Unlocking Financial Flexibility: Loans from SMSFs
A deep understanding of borrowing contracts is necessary for managing funds in a Self-Managed Superannuation Fund (SMSF).
A financial strategy called Limited Recourse Borrowing Arrangements (LRBA) enables SMSFs to borrow money to buy assets. This approach has inherent drawbacks and complications even though it may have advantages. The SMSF can obtain a loan for investment purposes thanks to the LRBA, which protects other fund assets from any risks related to the borrowed amount.
Understanding Loans from SMSFs
The super law typically forbids trustees of self-managed super funds (SMSFs) from taking out loans, with certain restricted exceptions. Limited recourse borrowing arrangements (LRBA) are one of these exclusions. An SMSF trustee obtains a loan from a third-party lender through an LRBA. The trustee then makes use of those funds to buy one item to be kept in a different trust, or a group of related assets with a similar market value.
Which loans from the SMSF are permitted?
There is not a lot of guidance from the ATO about the types of loans that trustees of SMSFs are permitted to offer. The loan must, however, adhere to the fund’s investment plan and act in the best interests of the members (i.e., not jeopardize the advantages of the members). Section 109 of the SIS Act stipulates that the loan must be executed on a commercial, arm’s length basis.
It’s crucial to negotiate fair terms for the loan, especially when connected parties are involved. As an illustration:
- The terms of the loan arrangement could potentially violate section 109 of the SIS Act and the sole purpose test, which SMSFs must always pass if the interest rate charged to a related party is excessively low (and benefits the borrower) or if the lender does not reserve the right to demand repayment;
- The loan arrangement may result in the SMSF earning “non-arms length income” for tax reasons, losing concessional tax status on that income, which is then taxed at the highest marginal rate, if the interest rate paid to the linked party is excessive (and benefits the SMSF as lender).
Key Benefits of Borrowing from SMSF
- Increase your potential for investment: You can buy a larger holding by supplementing a cash contribution from the SMSF with loan funds.
- Dividends and franking credits: A larger portfolio will give you more opportunities to benefit from any capital gains as well as dividends and related franking credits.
- Investment tax effectively: Depending on your individual tax circumstances, a margin loan may help you maximize the return on your investments after taxes by raising your franking credit exposure and deducting the interest paid on your loan from your taxes up to a certain amount (capped at the RBA’s Investor Standard Variable Housing Loan Indicator Lending Rate) plus 1%.
- Diversification: By utilizing loan funds to partially finance the acquisition of shares in a variety of firms, you may diversify your portfolio.
- Ownership: Your Super Lending Facility’s stocks are still beneficially owned by you.
Risk to Consider when Borrowing from SMSF
- Fall in value of portfolio: A margin call may be necessary if your portfolio’s loan-to-value ratio (LVR) drops below a specific threshold. To make up for the shortfall in value, you could have to sell equities or put extra security on your loan.
- Increase in interest rate: The amount that dividend receipts cover the financial expenses can decrease as interest rates rise.
- Legal: The position you hold might be negatively impacted by changes to the law.
The primary point to remember is that a member or a member’s relative cannot receive a personal loan from an SMSF or receive any other form of direct or indirect financial assistance from the fund.
Although it must adhere to the applicable regulations, SMSFs are permitted to lend to unaffiliated parties, such as a member’s acquaintance. It is not advisable for SMSFs to lend money or make investments that are not optimal for the SMSF.