One of the biggest differences of a self-managed super fund (SMSF) versus an industry, retail or corporate fund is the ability to use borrowed money to invest.
Remember that while borrowing money to invest can magnify gains, it can also magnify losses. Be cautious as excess borrowing can be catastrophic – as many investors learned the hard way during the depths of the global financial crisis.
Warnings aside, borrowing modest amounts of money within your budget in a rising property market can be lucrative for those with an appropriate appetite for risk.
In fact, over the past three years the amount of borrowing for property in SMSFs has quadrupled, admittedly from a low base. The east coast property boom has almost entirely contributed to this growth.
Since September 2007, it has been possible to borrow money from a bank to buy property in a SMSF via what is called a “limited recourse borrowing arrangement” (LRBA).
Limited recourse means that in the event of a loan default lenders can only take a security over the actual property for which the money was lent.
Despite many lenders requesting personal guarantees, this opportunity for superannuation investors presents a higher risk for lenders and SMSF loans often attract a slightly higher interest rate.
So too, banks are reluctant to lend more than 80 per cent of the value of a residential property or around 65 per cent of a commercial property. This percentage is called a loan to value ratio, or LVR to use a popular industry acronym.
When property values retreat, as well as your ability to service the loan, this LVR is essential in assessing your equity in a property. I always recommend paying off a property in a SMSF although many banks now offer interest-only loans that assist with optimising your cash flow. Times of record low interest rates are best used to repay debt.
There’s no shortage of rules and regulations that need to be observed when considering a property purchase in a SMSF.. Seeking professional advice from a specialist adviser is paramount.
Crazily, many of the lenders’ employees are unfamiliar with their own regulations owing to the high level of specialist knowledge needed, and real estate agents and property spruikers need to be strictly avoided when seeking advice.
If starting from scratch, expect to pay around $3000-5000 in accounting fees to establish the SMSF and LRBA plus potential establishment, legal and valuation fees from the lenders.
While many people may find the costs prohibitive, the nature of superannuation being a low-tax investment environment allows each member of a super fund to contribute up to $35,000 per annum (if you’re over 50) or $30,000 (if you’re under 50) from your gross salary each year into super. This is set to be changed to $25,000 a year for everyone under budget proposals.
Your gross income would usually be taxed at 19, 32.5, 37 or 45 per cent tax (plus levies) but super contributions are taxed at just 15 per cent (30 per cent if you earn over a certain threshold).
These lowly taxed contributions can then be used to repay the debt faster. So too, the positive effect can be magnified if a husband and wife are both making their maximum contributions to super and thus reducing the debt faster.
If you are five to 10 years away or more from retirement, have high income, a low aversion to risk and $200,000 or more in your combined super funds, then borrowing to buy property in a SMSF may be a worthy long-term strategy to grow your retirement savings.
For more information go to ato.gov.au and search “SMSF property” and make sure you seek advice from an expert who specialises in SMSFs and ideally is a member of the Self Managed Super Fund Association.
Financial planner Sam Henderson is chief executive of accounting, advice and funds management firm Henderson Maxwell.
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