Self Managed Super Funds: Five Things You Need To Know
If you have already set up a Self Managed Super Fund (SMSF), you have a regulated superannuation (super) fund with an established trust, an Australian business number, an ATO tax number and a bank account.
Moreover, you began a super fund of sufficient size (more than $200,000) to pay the initial costs of establishment and maintenance of the fund – $1000 to $1500 a year.
Managing SMSF Trusts
Here are some initial tips about administration and ways to manage your trust:
- You must fulfill all your administrative obligations including tax obligations, preparation all financial statements and maintain complete records.
- As required by the ATO, you should retain a competent auditor to assist you.
- You should know and keep up with the laws to comply with changing government regulations.
- Keep in mind it is illegal to prematurely access a super fund unless all conditions are met.
Investment Strategies
Defensive investments such as cash and bonds present little or no risk of losing money. Although returns may seem relatively high, the effects of inflation and taxes will lower the net return. All defensive, safe investments will never provide long-term capital gains.
The purchases of shares or property represent a capital growth investment and usually provide tax advantages. With capital growth investments, the increase in value is expected to grow faster than inflation and thus create real wealth.
However, growth is not guaranteed. In particular, share values will vary greatly over the investment period and will exhibit many ups and downs. Each year, gains or losses will be uncertain and could significantly differ from long-term estimates. Of even greater risk is the possibility that certain assets may lose value, never to regain it.
Historically, the increase in property values has proven to usually surpass inflation. Of course, again, this growth is not guaranteed. However, investment in commercial or residential rental property can provide a steady flow of income – purchased outright or as an investment of additional borrowed money in the form of a mortgage loan.
Laws Restrict SMSF Borrowing For Assets Such As Property
Laws restrict the types of assets for which self managed super fund trusts can borrow money. These laws also restrict the lender’s recourse if super trusts cannot meet their repayment obligations. Restrictions include:
- The asset is one the SMSF could legally acquire without borrowing.
- The asset is held on trust by a Security Trustee (Security Custodian) for the SMSF, and the SMSF acquires legal title from the Security Trustee after the loan repayment.
- The SMSF acquires an immediate beneficial interest in the asset.
- The lender has recourse against only that one asset. In the case of default, the lender is not able to place a claim on any other fund assets.
- The borrowing arrangement is for a “single acquirable asset.” In a subdivision, each title is a separate asset.
How Much Can You Borrow?
A majority of lenders consider loans to finance the purchase of investment properties for super funds as a small market. With the lender’s recourse limited and the complexity of loans to super fund trusts, many lenders consider a SMSF mortgage a low profit and high-risk investment.
Although an SMSF loan with a loan to value ratio (LVR) of 80% (80% of the value of the property) is possible, most lenders restrict LVR to 75% or less. LVRs of up to 70% are available for non-specialised commercial property. A few lenders do offer discounts.
How Will a Bank or Lender Assess My Loan?
Applicants must prove that the SMSF has sufficient trust income to support the loan. This value is based on the previous two years of tax returns. This amount is combined with the proposed rental income to determine if income is sufficient to service the debt.
Understanding the complexity of a SMSF loan is difficult for borrowers and lenders. As with any financial transaction, consult your financial advisers and include a mortgage broker experienced with the laws, restrictions and available lenders. An experienced mortgage broker that offers SMSF loans with access to many banks and lenders knows their assessment criteria and where to find the best interest rates.
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