Many people reeling from the recent turmoil in global financial markets are looking for different ways to invest their superannuation. At Apex Partners we are seeing increasing demand from clients to invest in property by establishing a Self Managed Superannuation Fund (SMSF).
How does a SMSF work?It works the same as a retail superannuation fund. It accepts contributions from members, and invests and manages those contributions and subsequent earnings. Importantly it must pass the “sole purpose test” of being set up for the sole purpose of providing retirement benefits.
You will be required to be a trustee of the SMSF and be involved in the decision making process of the fund. This means you will be responsible for tasks such as administration and accounting, managing tax implications and ensuring an investment strategy is in place.
The trustees of a SMSF are responsible for ensuring the SMSF remains compliant with the law. Your SMSF can have up to a maximum of four members (e.g. you, your partner and your children).
What are the benefits of a SMSF?
- You have control over how and where your money is invested
- Generally, there can be fee savings if you have more than $200,000 invested
- SMSF's offer the potential to use tax savings strategies not possible in other types of funds
- SMSF's can purchase your business’ real property
What are the limitations of a SMSF?
- You are responsible for making sure your fund complies with regulations
- You have to administer the fund (or pay a company to do it)
- Penalties for non-compliance range from financial penalties to imprisonment
- You are required to prepare, implement and regularly review the SMSFs investment strategy
SMSFs Can Now Borrow
Recent amendments to the Superannuation Industry (Supervision) Act 1993 ("SIS Act"), effective from 24 September 2007, now permit superannuation funds to borrow money of a limited recourse nature for investment purposes in certain circumstances.
The amendments provide an exception to the general prohibition of borrowing money by a SMSF under section 67(4A) of the SIS Act. The intent of the amending legislation is to permit a SMSF to invest in instalment warrant arrangements such as those in respect of ASX listed shares.
The amending legislation extends the borrowing exception beyond the acquisition of ASX listed shares and allows a SMSF to borrow money to acquire any asset which a SMSF is permitted by law to acquire directly.
A SMSF is now permitted to enter into an instalment warrant (borrowing) arrangement that meets the following criteria:
- the borrowing is applied to the acquisition of an asset;
- the asset is held on trust so that the SMSF acquires a beneficial interest in the asset;
- the SMSF has the right (but not the obligation) to acquire legal ownership of the original asset (or a replacement asset) by making one or more payments after acquiring the beneficial interest; and
- the rights of the lender against the SMSF for default on the borrowing (and charges related to the borrowing) are limited to the rights relating to the original asset (or replacement asset) that is, the borrowing is limited recourse.
A trustee of a self managed superannuation fund may borrow to acquire any asset other than one the SMSF is prohibited from acquiring under the SIS Act or any other law.
A SMSF would be permitted to acquire the following assets under an instalment warrant arrangement, this list is not exhaustive:
- Listed securities
- Commercial property
- Units in Widely Held Trusts
- Residential property
- Works of art/Other Collectables
- Shares in Private Companies
The in-house asset and prohibition from acquiring certain assets from a related party rules still apply.
Case Study: Borrowing to Purchase Residential Investment Property
- Peter is 40 years old.
- Peter is looking to purchase an investment property for $400,000 (net 5% yield)
- Peter owns his own home worth $850,000 and has a mortgage of $250,000
- Peter wants to fund the investment property through an equity line of credit against his principal residence
- Peter is employed and earns $100,000 per annum
- Peter has accumulated $200,000 in superannuation and has a SMSF
Peter could potentially fund the Investment Property purchase though his SMSF, utilising a SIS Act compliant loan with himself as the lender to his SMSF.
Step 1 – establish an equity line of credit (LOC) against principal residence and draw $300,000
Step 2 – personally lend $300,000 to superannuation fund via a “non –recourse” interest bearing loan. The rent payments can be used to repay the LOC interest
Step 3 – Establish Security Trust to hold the investment property, recognising the beneficial interest of the SMSF in the investment property and the rights of the lender
Step 4 - Once the Security Trust has been established, the SMSF then can acquire the property for $400,000 using the $300,000 loan and $100,000 in accumulated balance.
Note: the LOC could be reduced to $200,000 if the full balance of the SMSF was used for the property, although this would have asset allocation risk for the SMSF.
The benefits of Peter owning the Investment Property in his SMSF are compelling*
|
Individual and/or Trust |
SMSF | |
|
Rental Income (30yrs) |
$878,054 |
$878,054 |
|
Interest Expense (30yrs) |
($780,000) |
($585,000) |
|
Rental Tax Liability/Benefit (30yrs) |
($40,692) |
($9,921) |
|
Capital Gain on Property |
$418,563 |
$418,563 |
|
CGT Payable |
($86,852) |
$0 |
|
Total Return |
$389,073 |
$701,696 |
|
Structure Benefit |
$312,623 |
* Key Assumptions:
- 5% rental yield
- 2.5%pa rental growth
- 5%pa capital growth
- 41.5% individual tax rate
- 15% SMSF tax rate
- Asset held until > age 55
Further Enhancements to the Strategy - Putting the Strategy on Steriods!
Once Peter has established the loan to his SMSF, he then has greater flexibility in managing his superannuation contributions and funds flow. Peter could potentially increase his superannuation contributions via a salary sacrifice arrangement and then use the increased contributions and/or returns to repay the SMSF loan.
This would enable Peter to save tax not only on the property investment, but also at a personal income tax level.
For more information, or to see if a SMSF would be right for your financial situation, please contact Ryan Love from Apex Partners on 1300 856 338 to discuss.
Disclaimer and Disclosure This publication has been prepared and issued by Apex Partners Pty Ltd. While the information contained in this document has been prepared with all reasonable care no responsibility or liability is accepted for any errors or omissions or misstatement however caused. All forecasts and estimates are based on certain assumptions which may change. If those assumptions change, our forecasts and estimates may also change.