Self-Managed Super Fund
Not any superannuation fund can purchase direct property. In order to purchase a property using superannuation monies, a Self-Managed Super Fund (SMSF) must first be established.
A SMSF works very similar to your standard industry or retail superannuation fund. It receives your superannuation contributions, it invests those contributions, and you are able to access those contributions once you have met a condition of release. Usually this means retirement.
A SMSF may provide benefits such as flexibility, greater investment choice, and further control of your superannuation monies.
It provides greater flexibility of investment as it is the only type of fund that allows you to invest in direct property.
It also provides you with more control as you, as a trustee of the fund, have ultimate control around your superannuation monies, and its operations.
Further, a SMSF may also have up to 4 people as members. This allows your partner, your children and yourself to pool your superannuation monies together and invest collectively into direct property (or any other investment within your SMSF).
Despite having the capacity to purchase a direct investment such as property, it is not necessarily as straight forward as purchasing a property outside of superannuation.
In addition to your generic requirements, a property inside super must also meet the superannuation legislation.
Part of meeting the superannuation legislation requirements is meeting the ‘sole purpose’ test. This means that any property you wish to purchase, must be for the sole purpose of increasing the funds available in your superannuation account. Therefore if you are thinking about purchasing a property for your kids to live in, for a holiday home, or for you to move into, think again.
The exception to this rule is commercial property. A member of a superannuation fund may rent a commercial premises owned by their superannuation fund for business purposes only. The business must pay market rent to comply with the superannuation legislation.
In addition to establishing a SMSF, and complying with the superannuation legislation, you will need to set up a specific type of trust known as Bare Trust or Custodian Trust. This is a further tool required to purchase a property inside of super (If you wish to use borrowed funds).
Under current superannuation laws, no super fund has the ability to borrow without the use of a Bare Trust.
Despite the establishment of this secondary trust, your original SMSF will still maintain practical control over the investment and its operations.
Below is an illustration of how the purchase of a property inside a SMSF may work with borrowed monies.
There is a specific type of loan that a superannuation fund must apply for when looking to borrow. This loan is called a Limited Recourse Borrowing Arrangement (LRBA).
Whilst the process of establishing a loan for a SMSF is similar to any other Investment Property loan, under a LRBA, your liability is limited to the asset that was purchased with the loan. This means that the SMSF has more security in the event it defaults on the loan for any reason.
For example, if you purchased an investment property with a limited recourse loan, and then defaulted on the loan, your lender can only take possession of your property to satisfy the loan, even if the value of the property has dropped and is not enough to cover the loan balance.
This has been done in accordance with the existing superannuation laws which limit borrowing inside of superannuation.
In order to get around these laws, banks will often ask for personal guarantees on the loan. This means that in the event your SMSF defaults on the loan, whilst the bank cannot touch any further money in your SMSF, they can ask you personally to come up with the difference. Keep this in mind when looking to purchase a property.
After having a better understanding of the different elements to a purchase inside the superannuation environment, we need to have a better understanding of the process to purchase a property inside of superannuation.
To assist, please see below:
- Establish a bank account within the SMSF and transfer your existing superannuation benefits into your SMSF account. Prior to moving your existing super into a SMSF, review your existing insurances. Once your existing super has been transferred, your existing insurance cover may be cancelled and may hinder your current position.
- Once your SMSF has been established and superannuation funds transferred into the SMSF bank account, determine what your budget on the property is. Generally speaking a bank may loan up to 80.00% of the value of your investment property. Whilst this is also the case with some lenders in the SMSF space, a more conservative approach may prove beneficial. Consider a 70.00% loan as a maximum.
- Once the property and the loan have been found the acquisition process of any other property applies with a couple of additions:
- The lender will want your SMSF and Bare Trust documents to be read by their solicitors.
- A Financial Adviser may be required to sign off on the purchase and confirm that you have received some advice (however limited) on your new property.
- Upon settlement, any future expenses are to be paid via the SMSF bank account (including loan repayments) and any rental income the property generates will be deposited into the SMSF cash account.
Benefits of Property Inside Super
- Your deposit and all acquisition costs are paid using pre-tax super monies.
- Your ‘out of pocket’ cash flow commitment is reduced as your SGC (employer contributions) may assist in the maintenance of the property.
- All rental income received is taxed at 15% as opposed to your individual marginal tax rate.
- Capital gains tax is reduced to 10% if the property is held for more than 12 months and potentially eliminated if the asset is held to retirement.
- You can pool your balances with relatives (up to a maximum of 4 members) and increase your leveraging and purchase options.
Risks of Property Inside Super
- The lender’s serviceability criteria is different (often more restricted) compared to purchasing an investment property outside of super.
- The lending arrangements, the trustee structure, the type of property, the taxation implications, and the overall cash-flow position of the SMSF all have an effect on each other and should be considered together before acquiring a property.
- The sole purpose of the SMSF is to provide for your retirement and therefore fringe benefits, such as purchasing a property from a related party or using the property as a holiday home are not allowed.
- As with all superannuation investments, you cannot access the fund for personal use until you meet a condition of release.
- The SMSF must be audited annually. This may incur additional costs to hold the property.
- The SMSF trust deed must allow for borrowing within the fund and contain a documented investment strategy.
- Borrowing to invest magnifies both the potential for gains and losses. Even if the lender’s recourse is limited to the asset acquired, if your SMSF is unable to make repayments and the lenders foreclose, your SMSF still stands to make a loss. You may also be personally liable for any difference in outstanding debt.
- The SMSF trustees must consider appropriate insurances as part of the investment strategy.
- Due to the limited recourse nature of the loan, lenders will generally charge a premium above the standard interest rate. They will also have limits on what percentage of the property the bank will lend towards. This may be a maximum of 80.00% in the current market.
In summary, whilst there are many reasons and advantages to using your existing superannuation funds to purchase a property, careful consideration must be taken into account prior to the purchase.
The banks have identified this, which is why it is a requirement for each property strategy to be signed off by a financial adviser.
If purchasing a property within a Self-Managed Super Fund interests you and should you wish to obtain further information, please feel free to contact the office of M&A Wealth and an Adviser would be happy to discuss your options with you.
General Advice Warning
The information provided in this article is general in nature and does not constitute personal financial advice. Before acting on any information, you should consider the appropriateness of the information provided having regard to your current position.