By Peter Freeman
Money magazine, December edition
A self-managed fund can lend as well as borrow, says Peter Freeman
There has been a lot of attention given recently to the relatively new ability of self-managed superannuation funds to establish arrangements that, in effect, allow them to borrow to buy property. This ability to gear into real estate is seen by some as an excellent way for SMSFs to boost their potential long-term returns, although others warn that this sort of strategy can go badly wrong.
While the issue of whether or not an SMSF should borrow is an important one, the flipside – whether it should lend money – is also worth considering.
From one perspective, the answer is relatively straightforward. Provided your SMSF’s trust deed and investment strategy allow it to make loans, and the loan you are considering making will be well secured and will generate a competitive rate of return, then the loan is likely to stack up as an acceptable investment. As usual with super, however, the issue isn’t quite this straightforward since there is a range of other restrictions that have to be considered.
Patrick MacNamara, a client manager with the Self-Managed Super Institute, says the three main ones are the so-called sole purpose test, the restriction on making loans to related parties and, when you do make that type of loan, the need to comply with the 5% “in-house” assets limit.
“The sole purpose test states, in effect, that all the investments made by an SMSF should have the sole purpose of building up savings for your retirement,” he explains.
The relevance of this requirement when an SMSF is making a loan is the way it requires the loan to be made on commercial terms. Making a loan that charges less than the market rate would deliver a benefit to the borrower and so contravene the sole purpose test.
In any case, Section 65 of the Superannuation Industry (Supervision) legislation basically prohibits an SMSF lending to a related party, such as the fund’s members and their relatives. Under section 71 this ban also applies, in effect, to situations where a non-related party is interposed in the loan arrangement.
The main concession is provided under the in-house assets test rule. This allows an SMSF to hold 5% of its total assets in the form of in-house assets, a category that includes loans to related parties.
MacNamara stresses that even if your SMSF can comply with all these rules, it is important to
follow the tax office advice to:
• Draw up an appropriate loan agreement and have it signed by all the parties involved.
• Ensure the agreement covers all the key terms of the loan such as the security being provided, the repayment period, when repayments will be made, the amount of the repayments and the interest rate.
• Make sure your SMSF receives the repayments as specified.
Finally, if the loan agreement is breached it is the responsibility of the trustees to take action to protect the interests of their SMSF.
There has been a lot of speculation that the Gillard government is looking to boost its budget bottom line by cutting back superannuation tax concessions. One rumour is that it will force super funds to realise capital gains before a member starts a pension. Another is that new restrictions on gearing will be introduced.
But while the sad truth is that some of this speculation might well turn out to be true, those running SMSFs would be well advised simply to get on with the job of investing their super as wisely as possible. As the history of super’s frequent rule changes highlight, trying to anticipate the government’s next move is a virtually impossible challenge.
Subscribe to Money magazine here.