By Peter Freeman
Money magazine, February edition
Peter Freeman explains why you might borrow from a fund member
When the trustees of a self-managed super fund embrace “limited recourse borrowing”, a strategy available to SMSFs since late 2007, they usually get the loan from a mainstream lender. Generally this makes good sense but, as Scott Quinn, the technical manager with ANZ subsidiary OnePath, explains, it is sometimes sensible to get the loan from a member of the fund. This avoids the need to comply with the sometimes costly conditions imposed by some lenders, including the possible need to rewrite the fund’s trust deed to satisfy the lender’s requirements.
Quinn says that, in some cases, the initial motivation when a member makes a loan to an SMSF is not so much to avoid dealing with mainstream lenders, but rather simply the desire of a member to lend to the fund.
There are a number of reasons why this might be a sensible strategy. One is that the SMSF will pay less tax on any earnings it makes from investing the money it borrows. Realising capital gains can even be postponed until fund members are in the tax-free pension phase. Some members may want to lend to their SMSF because they are close to or at their contribution caps for the financial year. Others can no longer contribute because they are 65 or older and no longer satisfy the relevant work test.
There is also the situation where the members of an SMSF want to build up the fund without losing access to the extra money invested. In contrast to contributions, which usually can’t be withdrawn until you retire, your SMSF has the right to repay its borrowings at any time.
While this is technically correct, Quinn stresses that trustees have to act solely in the interest of fund members in building up their retirement savings. Selling assets and repaying a loan may conflict with this obligation.
The ability to lend to your SMSF may be due to the fact you are wealthy; others may have received an inheritance, while still others may have sold a property, perhaps because they have traded down to a smaller, cheaper home.
Money can also be generated by taking out a loan against your home or other assets, although, as Quinn cautions, the tax deductibility of the interest you are charged on the loan can get complicated.
But whatever your motive and source of funds, it is crucial to pay close attention to two issues: the structure of the loan and the interest rate you charge your fund.
As Quinn explains, you have to use the same structure required for a standard loan to an SMSF. This means it has to be a formal limited recourse borrowing arrangement, which can cost between $2000 and $5000 to set up.
As for the interest rate, while the superannuation rules prevent you charging your SMSF an above-market rate, tax office Interpretative Decision 2010/162 suggests it may be possible to charge a below-market rate, possibly even zero.
But charging zero interest may prompt tax office queries. As well, there has been some speculation that the government may make it mandatory to charge a market rate of interest.
A government announcement late last year has removed the risk that earnings generated by assets backing an account-based pension will lose their tax-free status if the member receiving the pension dies.
The rule change will apply to deaths occurring after June 30, 2012. Prior to the announcement, a deceased member’s beneficiaries risked having to pay tax on the income and capital gains made on the assets backing the pension. This was because the pension was deemed to have ceased on the member’s death, triggering the standard 15% tax on income and 10% tax on gains. The latter was potentially very large, as many pension assets have been held for a long time.
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