Can Self-Managed Super Funds Borrow?
Written by: Accounting Team
So, you have a Self-Managed Super Fund, SMSF for short (or maybe you are considering establishing one).
A whole range of possibilities are available for structuring and investing the SMSF assets;
- Cash accounts;
- Term deposits;
- Shares; and
- Managed funds, to name a few
But – where to start? Maybe you have come across an opportunity in the shape of an investment property, yet your SMSF does not have enough cash to purchase it outright? Is your self-managed super fund allowed to borrow money to make up the funds needed?
A Self-Managed Super Fund can borrow money, just not as freely as you may expect (or even prefer). The rules and circumstances for an SMSF borrowing money are not the same as if you were borrowing money in your personal name, or that of any other entity (like a company), the stakes and compliance are higher. SMSF borrowing is a specific exception in the Superannuation legislation, and not just a given. There are strict regulations and guidelines that must be followed to avoid potential penalties and consequences.
When It Comes To Borrowing In Your SMSF, What Can You Do?
Superannuation legislation restricts the circumstances in which SMSFs can borrow money. The most well-known, and well-utilised, of these circumstances are limited resource borrowing arrangements (LRBA) used to fund the purchase of a single asset – usually real property – or even a collection of identical assets that have the same market value (considered a ‘single acquirable asset’).
A new acronym! More jargon, more letters. Not again…
Onto learning your LRBAs! Limited Resource Borrowing Arrangement
Want to know more about Self-Managed Super Funds and the power that they hold? Check out this recent blog we put together: How Are Self-Managed Super Funds Taxed?
What Is A Limited Resource Borrowing Arrangement?
At the core, it is borrowing with special conditions and structure.
Some frequently asked questions are;
“How does this differ from other borrowing?”
It’s in the name – limited resource. In the event of a default, the lender’s only right (or recourse) is limited to the asset purchased under the LRBA.
If your SMSF borrows with an LRBA to purchase a residential property and then defaults on the arrangement, the lender cannot make a claim on any of the SMSF assets outside the LRBA (for example other shares/investments held by the SMSF).
To achieve this, the single asset must be held in trust by a third party until the borrowing is repaid in full. A Bare Trust (also referred to as a holding trust) is established to separate the legal ownership of the asset from the other SMSF assets, with the SMSF Trustee having a beneficial interest in the investment.
“What are some considerations?”
Self-Managed Super Funds Trustees + Considerations
The SMSF Trustees need to consider a wide range of areas for the whole operation of the fund, not just for SMSF borrowing. Importantly and before entering a LRBA, consideration must be made for at least the following (and other issues not covered here):
- Does the arrangement meet the super legislation requirements (and this can differ depending on when the arrangement commenced)?
- Can the Self-Managed Super Fund meet all future obligations under the arrangement such as loan repayments, future interest rate rises, a member leaving the fund, existing expenses for accounting and audit etc.?
- Is the arrangement consistent with the SMSF investment strategy?
- What is the quality of the asset/investment under consideration?
- Does the borrowing and purchase of the asset meet the Sole Purpose Test (maximising retirement benefits of the fund and not for personal gain or benefit)?
- Does the SMSF Trust Deed (the governing rules) allow the fund to borrow or enter an LRBA? Spoiler: Many older trust deeds do not!
“What cannot be done with borrowed funds?”
Borrowed funds can only be used to acquire certain types of assets, such as real estate or listed securities, the ‘single acquirable asset’. Borrowed funds cannot be used:
- To improve an asset, for example, work that is above repairs and maintenance for the continued functioning of a property.
- To develop an existing asset, for example, to buy a vacant block of land and develop it.
- To purchase assets from a related party that are not exempt under the existing related party rules (market value acquisition of listed securities or business real property).
It is also worth noting that borrowing within an SMSF involves additional complexity and administrative responsibilities. Trustees must ensure that all legal and financial obligations are met not just by meeting the loan repayments, but also through maintenance of proper records, and compliance with reporting requirements.
Should Self-Managed Super Funds Borrow, Why + Why Not
“Just because they can, does it mean they should?”
Whether a fund should borrow depends on various factors, including the specific circumstances of the fund, the investment objectives of the trustees, risk tolerance, and regulatory compliance considerations.
We now know that Self-Managed Super Funds can borrow money in certain circumstances and the option to borrow money through a LRBA presents both opportunities and challenges. On the one hand, borrowing within an SMSF can potentially enhance returns by allowing access to investments that may otherwise be out of reach, such as real property. However, while limited resource borrowing can mitigate some risks to the asset purchased, it also adds complexity and costs to the SMSF. Trustees must ensure strict adherence to regulatory guidelines set by the Australian Taxation Office (ATO) to avoid penalties and maintain compliance.
Want to know more about when you should look to make a Self-Managed Super Fund? Check out this recent blog we put together: How Much Money Do I Really Need For A Self-Managed Super Fund?
Canny Advisory, Experts in Self-Managed Super Funds
While borrowing within an SMSF can provide opportunities for diversification and growth, it’s essential to proceed with caution and seek professional advice to ensure compliance with the super laws.
Whether you are considering establishing a Self-Managed Super Fund, already have one or you’re on the hunt for a new SMSF Accountant, our team at Canny Advisory offers individually tailored ongoing service packages to all of our SMSF clients. Want to know more? The team at Canny Advisory can assist!
Get in touch to talk about your Self-Managed Super Fund plans!
