Many Australians are making the switch to having a Self Managed Super Fund or SMSF so that they have direct control over where their money is invested. An SMSF is a retirement savings vehicle similar to the super accounts that most working Australians have; the critical difference is that those involved are usually trustees of the fund, as opposed to members. But can a SMSF borrow money and under what circumstances?
How can an SMSF borrow money?
Let's imagine that Francine has built up a balance of $400,000 in her retail superannuation fund. After doing her research, she decides to set up an SMSF, following the legal frameworks, appointing herself and another person as a trustee. Francine has the skills to keep tabs on her investments and ensure her fund is performing well. One of her goals is to acquire a piece of property as an investment toward her superannuation balance and future retirement savings.
People in Francine's position need to understand that generally, borrowing money or taking a loan is not allowed for SMSFs. There are only a handful of occasions during which a fund can apply for a loan. However, the Australian super laws provide one method by which an SMSF can take a loan to fund the purchase of an asset, most often in the form of a property.
This method is known as a Limited Recourse Borrowing Arrangement or LRBA. An LRBA is a particular type of loan that protects the SMSF, its trustees and its assets from lenders if a default occurs on the loan. Let's illustrate this to see how these work.
In our scenario, Francine is interested in acquiring a loan for her SMSF to purchase an investment property. Her aim is for the fund to benefit from the property's rental income and the potential appreciation in the home's value over time. This point is essential; SMSFs are regularly audited, and the intent of the investment must be explicit. Francine will have to make it clear that she is only investing for the benefit of her retirement savings. She may not pocket rental incomes or potential earnings from equity if she decides to sell the asset. The fund's trustee becomes the beneficiary of all gains from the investment. She works with a skilled finance professional, like CJG Finance to ensure that she complies with all regulations and does not face serious investigations or possible legal consequences.
Francine carefully ensures that her loan is a Limited Recourse Borrowing Arrangement. By doing this, if her fund defaults on its repayments to the lender, the lender may only take action against the asset itself to recoup the value of the loan. The lender may not take action against her fund's other assets and investments. Francine is protected; the lender's recourse is limited to the property. In this way, the property becomes collateral for the loan. She is also compliant with all super legislation.
Francine works hard to ensure that her fund continues to grow over the years, and eventually, the fund has fully repaid its loan to the lender. A holding trust or bare trust has legally owned all of this time, the property. This holding trust represents the asset separately from the SMSF that Francine has set up. The holding trust now can transfer ownership of the asset to her SMSF and continue to receive income from it. Excellent work, Francine!
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If you're considering using your super to buy a house, whether it be a residential or commercial investment property, talk to our SMSF Finance expert and let us help you find the right finance solution for your needs.