Client presentation on the benefits of a SMSF and the process for a SMSF to use the borrowing rules to invest in property. Includes the different ways of getting property into a fund and how to finance them.
There are many benefits associated with using superannuation as an investment vehicle to save for retirement. Superannuation is a tax structure, in simple terms it is really a type of trust. Superannuation is designed as a mechanism to save for retirement. What separates a superannuation trust from the other types of trusts (eg family trust) is that it is concessionally taxed. There are separate tax consequences in relation to superannuation, however as a result there are strict rules associated with superannuation in order to maintain the concessional tax treatment. It is a fantastic way to save for retirement, however it must be noted that there are preservation rules, which preserve any investments into superannuation until retirement or until another condition of release has been satisfied.
As the name suggests an SMSF is a superannuation fund that is managed by the members (you) in their capacity as trustees of that fund. What is a trustee? A trustee is the controller of the fund. A trustee can be either and individual or a company. The trustee is responsible for making the decisions as well as managing the SMSF. SMSFs are regulated by the Australian taxation office and must adhere to the same legislative requirements as retail or industry superannuation funds.
Source: ATO Self-managed super fund statistical report - September 2011 statistics
There are may advantages to have an SMSF compared to a retail or industry fund. Having an SMSF as a retirement savings vehicle provides the members with more flexibility. There is a wider investment choice available when using an SMSF compared to a retail fund. One of the bigger benefits in relation to investment choice is the ability to invest in direct property and transfer personally owned assets into the fund. Another benefit is that you have a fund set up with family member, for example mum and dad may set up a fund with their children. Although the set-up costs of an SMSF are generally higher, the ongoing fees are usually a lot less and more transparent than with a retail fund. Lastly with a SMSF the members must also be trustees (or directors of the body corporate) of the SMSF, therefore they have complete control of the fund. However with control also comes a burden as trustees will need to be on top of the legal requirements in relation to keeping the SMSF compliant. Using a retail or industry fund removes those extra responsibilities, as well as the flexibility.
An investment strategy is a requirement for all superannuation funds. With an SMSF the trustees are responsible to ensure an appropriate investment strategy is in place. The investment strategy must take into account your appetite to risk and reflect your financial goals for retirement. A good investment strategy will provide diversification, ‘don’t put all your eggs in the one basket’, it will also make sure the members needs are met, eg. liquidity when a member moves to pension phase. There are no restrictions in terms of the types of investments your superannuation fund invests in, as long as the investment meets the legislative requirements under the SIS Act. A financial adviser can assist you as the trustee in putting together an investment strategy that is suitable to achieve your goals.
The investment choice available through an SMSF is very broad. Trustees can invest in anything from direct property, to shares, managed funds to artwork and collectables. Although there is a wide investment choice, it is important that appropriate steps are taken to the superannuation fund is compliant at all times. Superannuation is indented for retirement savings and for that reason members cannot personally use the assets that a superannuation fund invests in. This means that if you choose to invest in exotic cars for example, you cannot use them personally, therefore nice Sunday drives down the coast are out of the picture. They must be stored and insured according to legislative requirements. If you want to invest in these lifestyle assets, its important you get appropriate advice before hand. For the purpose of this presentation, we will focus on property as an investment within superannuation.
There are many benefits associated with investing in property using superannuation monies. Given superannuation is a concessionally taxed environment; any rental income derived from the property will be taxed at a maximum of 15 per cent. This means that you are effectively swapping a potential marginal rate of up to 46.5 per cent for 15 per cent. It gets even better when you move to pension phase as any rental income derived is completely tax free. Similarly if the property is sold when you are in pension phase, any capital gains will also be tax free. Another benefit, particularly for business owners in the room is that there is an exemption in the superannuation legislation that allows you to transfer your business real property into your superannuation fund. This is a great benefit because it means that you can move your existing asset into your superannuation fund, without disruption to your business. If you transfer your personally owned property into superannuation, it may trigger a capital gains tax event, however there are small business tax concessions that may be applied to alleviate or potentially eliminate any applicable tax. In addition to that depending on the relevant state laws, there may be exemptions to stamp duty as well. It is important that I point out that this exemption only applies to business real property; business real property is defined as an asset that is wholly and exclusively used in the course of a business, for example a factory or an office building. An investment property does not fit this description and therefore cannot be transferred into superannuation. If you are wanting to invest in an investment property via your SMSF, you will need to purchase it from a third party, ie not a related party. A related party includes but not limited to, members of the fund, relatives of members and business partners and associates.
There are many ways in which you can get property into your superannuation fund. (List the dot points on the slide) We’ll now go through each of the options.
Option one – Using the funds existing capital to purchase a property outright. This is an effective way to invest in property within your SMSF. As we have already discussed there are many benefits associated with investment in property via an SMSF. All earnings within the fund will be taxed at a maximum of 15 per cent compared to adult marginal rates outside superannuation. Similarly any capital gains are also limited to a maximum of 15 per cent. It is important to make sure that all transactions within superannuation are done at arm’s length. This means that all purchases must be at market value. Once again a reminder, if you are intending on purchasing a residential property, it cannot be acquired from a related party. If you are unsure what constitutes a related party, ensure you seek appropriate advice prior to implementing this strategy.
Option two- make an in specie contribution to superannuation. This strategy really only applies to clients who own commercial property (as defined as business real property), therefore it really works well for small business owners who run a business out of a property that they own. Making an in specie contribution is really transferring the asset from one owner to another and as a result it may trigger a capital gains tax event. This means that the taxpayer (you) who transfers the asset may be subject to capital gains tax. Given the asset is a business asset there are provisions within the legislation that may assist in alleviating or potentially eliminating the capital gain completely. Other issues that need to be considered is whether you are eligible to make a contribution. There are specific rules within the legislation that dictate who can make a contribution to superannuation. In addition to the rules, there are also limitations in terms of how much you an contribute in any one financial year.
Option 3 – The last option is to set up a limited recourse borrowing arrangement within your SMSF. The legislation has changed to allow superannuation funds to borrow money to invest in property. There are a number of strict rules that an SMSF must adhere to in order to be able to use this provision. This strategy allows individuals to gear within their SMSF and use the income (rent) generated as well as contributions in the fund to service the debt. In addition given the investment is held in superannuation, all the tax concessions usually available to superannuation will apply.
The SMSF can choose any property that it would be able to purchase under the legislaiton. The property must be purchased on an arms length basis. This includes business real property owned by the members or another related party. The legal title to the property must be held on trust by an independent trustee (the “Holding Trustee&quot;). The holding trustee must not be the trustee of the SMSF (you can’t hold an asset in trust for yourself). The holding trustee can be another company owned or controlled by a member of the SMSF. The beneficial title to the property will be held by the SMSF. The SMSF borrows directly from the lender on a limited recourse basis. The only recourse the lender has is against the property being purchased. This means that in the event of default on the loan, the lender can only recoup their loses from the acquired asset and not the other assets of the superannuation fund. The holding trustee will provide a mortgage over the property in favour of the lender.
Lets have a look at the diagram which describes this arrangement. The fund trustee acquires the beneficial interest in the asset (receiving all income and deductions and paying all ongoing expenses in relation to the asset and borrowings) however is not the legal owner of the asset - the asset is held on separate trust. The holding trust should be a bare trust, with all of the accounting for the asset’s income and expenses taking place in the superannuation fund. The rights of the lender against the fund trustee, in relation to the borrowing and any related expenses, are limited to the rights relating to the asset, ie in the event of default the lender can take possession of or dispose of the asset but can not access any of the other assets of the super fund. As well as allowing for super funds to invest in commercially available traditional instalment warrant products, the rules allow super fund trustees to enter into a tailored gearing arrangement to acquire a specified asset, such as real property. The super fund can choose any property that it would be able to purchase under legislation. The property must be purchased on an arms length basis, this means that the market rates must be paid for the property. This includes business real property owned by the members or another related party. The legal title to the property must be held on trust by an independent trustee (the “Holding trust Trustee&quot;). The Holding Trustee must not be the trustee of the SMSF (you can’t hold an asset in trust for yourself). The Holding Trustee can be another company owned or controlled by a member of the SMSF. The beneficial title to the property will be held by the SMSF. The SMSF borrows directly from the Lender on a limited recourse basis. The only recourse the lender has is against the property being purchased. The Holding Trustee will provide a mortgage over the property in favour of the lender. The borrowed money together with the 1 st instalment from the SMSF are paid to the vendor in exchange of the property. The holding trust is the legal owner of the property and the SMSF has beneficial ownership. Any income derived from the property goes to the SMSF and the SMSF is responsible for making the payments. Once the loan has been completely paid, the property can be transferred to the SMSF.
There are no restrictions under superannuation legislation in terms of who the lender can be under a limited recourse borrowing arrangement. This means an SMSF can borrow money from any bank or institution that provides these product, including you as a member, as long as the arrangement is at arm’s length (commercial rates). Since the legislation prohibits the lender from having recourse over other fund’s assets, most commercial lenders will request personal guarantees from the members. This means that the member will need to use their personal assets held outside of superannuation to guarantee the borrowing.
You as the member of the SMSF can lend money to the superannuation fund. This can be done in a number of ways. If you have existing capital, you can lend that to the superannuation fund and charge an appropriate interest rate applicable to the particular arrangement. Alternatively, like most of us who don’t have that sort of money lying around, you can get a loan in your own personal name and on lend it to your SMSF. If you choose this path, the interest for the loan you have taken out will be deductible to you personally, however the repayments (interest component) received from the superannuation fund by you personally will be subject to tax . This is becoming a more common approach as it provides more flexibility for the members.
Gearing is not the strategy for everyone. It’s suited to those who have: Little or no capacity to save quickly in Super to afford a property at current values Higher tolerance to risk Financial goals cannot be met other ways (e.g. term deposits) A long-term investment horizon Pre-retirement savings goals Note, this means gearing probably is not suitable for those close to retirement who have a shorter investment time frame. You also need the right economic conditions . Gearing will work best in a period of relatively low interest rates (particularly against borrowings you will need to make) in a property market that has potential for capital growth.
It is extremely important to match your tolerance to risk with an appropriate strategy. As always, advice specific to your situation is highly recommended. Is this your profile? To identify your risk profile and decide if gearing is for you, you need to understand and consider: Time frame: What is the time horizon for you investments? Gearing is a long term strategy. Liquidity required: Do you need ready access to your funds? Falls and rises: Are you comfortable with share market falls as well as rises? Sometimes, a falling market can present opportunities to investors comfortable with risk Savings goals: What are your savings goals? If you merely need to save for an overseas holiday in two years time, a different investment option may be better suited – such as a fixed term investment. Cash flow: You need to have a reasonable cash flow so if interest rates rise, you’ll have cash on hand to make addition contributions to superannuation to cover the rise.
Some other risk considerations for your geared investments may include: Inflation risk – you want your geared investment to at least keep up (and really outpace) inflation. Interest rate risk – if interest rates go up significantly, your loan repayments will increase. Market risk – the market could fall. Market timing risk – For example, you may need to get out of the market at a time when it’s down. Diversification risk – What other sort of investments do you have? It’s important to diversify to reduce risk. Liquidity risk - The risk that your investments cannot be sold when you require the cash. Legislative risk - The risk that legislation may change to make gearing a less attractive strategy. For example if the interest expense of a gearing investment became non-deductible this would not only remove an advantage of gearing, but may, in some cases, make it unaffordable for many people.
SMSFs - Super & Property, what's the big deal
SMSFs – What’s the big deal?The SMSF Coach - Liam Shorte BBS ADFS SSASMSF Specialist Advisor™Authorised RepresentativeGenesys Wealth Advisers
Important InformationThis presentation has been prepared by GenesysWealth Advisers Limited ABN 20 060 778 216,Australian Financial Services License Number 232686and Principal member of the FPA. Any advicecontained in this presentation is general advice onlyand does not take into consideration the participantspersonal circumstances.To avoid making a decision not appropriate to you thecontent should not be relied upon or act as asubstitute for receiving financial advice suitable toyour circumstances. Any reference to the participantsactual circumstances is entirely coincidental. Whenconsidering a financial product please consider theProduct Disclosure Statement. Genesys and itsrepresentatives receive fees and brokerage from theprovision of financial advice or placement of financialproducts.
Benefits of superannuation• Most tax effective structure for retirement savings. Investment earnings when in accumulation phase taxed at a maximum of 15 per cent. Investment earnings tax free in retirement (pension phase). Tax deductions may be available for contributions to employers & certain individuals. Benefits (either lump sum or pension)withdrawn from age 60 are tax free to the member. Protection from creditors.
What is an SMSF? • An SMSF (self-managed superannuation fund) is a small superannuation fund managed by the members. • Regulated by the Australian Taxation Office. • Same tax implications as retail and industry funds.
Market statistics• Total number of SMSFs is 450,498 (September 2011).• $397 billion total assets: $14.8 billion – residential real property $45.4 billion – non-residential property.• 56% of members above age 55 (as at end of June 2011).Source: ATO SMSF Statistical Report and APRA Quarterly report.
SMSF vs. Retail/Industry fundSMSF Retail/Industry• More diverse investment • Less administrative choice . burden.• Members have more • Limited investment control of investment choice. decisions. • Limited flexibility.• More control of administrative/policy/rules.• Ability to transfer. personally owned assets (restrictions apply).• Family funds – members can be relatives.• Reduced fees.
Investment strategy• A written investment strategy is a legislative requirement for the trustees of an SMSF.• Sets out the investment objective for the fund, and how the strategy will be achieved taking into account: risk diversification ability to pay benefits needs of members.• Can only be provided by the trustees themselves or a licensed financial planner and should be reviewed regularly.• Check the trust deed before investments are made.
Investments• SMSFs provide a diverse investment choice A SMSF can invest in: Direct property: residential property commercial property. Direct equities: listed securities/shares. Managed funds: widely-held unit trusts. Artwork and collectables: paintings exotic cars wine yachts.
Benefits of holding property in an SMSF• Tax benefits: marginal tax rate vs. superannuation fund tax rate (15%) pension phase investment earnings tax free no capital gains tax payable when sold in pension phase.• Can purchase commercial property from related parties: an exception in the legislation applies to business real property (commercial property) can transfer personally owned business real property into the SMSF tax concessions may apply to alleviate or potentially eliminate capital gains tax upon transfer potential stamp duty exceptions. • Note: an SMSF can invest in residential property, however it must be purchased from a non-related party.
How to get property into yourSMSF?• There are a number of ways in which you can get property into your superannuation fund, including but not limited to: buy it outright using the superannuation fund’s money make an in specie contribution buy it using borrowed money, under a limited recourse borrowing arrangement.
Option 1 – buy property outright• The SMSF can purchase either residential or commercial property outright, using the fund’s money.• Use the fund’s existing capital to purchase the property outright.• Transaction must be at arm’s length.• Residential property cannot be purchased from a related party.
Option 2 – make an in speciecontribution• Contribute personally owned business real property into your superannuation fund.• Increases the capital of your superannuation.• May be eligible for capital gains tax concessions.• Ensure you are eligible to make a contribution to superannuation.• Ensure you are within you contribution caps.
Option 3 – purchase propertyusing borrowed money• An SMSF can now borrow to purchase a property under a limited recourse borrowing arrangement.• Leverage within superannuation.• Use income and contributions to service debt.• Obtain tax concessions ordinarily available within superannuation.
Option 3 – how does it work?• The borrowing must be to purchase an asset the SMSF could ordinarily purchase under the legislation: the borrowing can be used for expenses associated with the acquisition .• The asset must be held on trust.• Rights of the lender are limited to the underlying asset.• When borrowing is repaid the SMSF has the right to acquire the asset.
Option 3 - how does it work? Loan – limited recourse Repayments + interest SMSF Beneficial ownership =Borrowings + income Guarantee /1 instalment st mortgage Legal owner Vendor Holding trust Transfer of asset
Option 3 – lending options• SMSFs can borrow from any lender (including you as a related party loan)• Commercial Lenders include: NAB CBA Westpac St George Macquarie Some specialist lenders .• LVRs apply.• Personal guarantees.
Option 3 – lending options• All Lenders require specific powers in the SMSF Trust deed so you will need an updated deed containing: power to borrow power to give security power to appoint a nominee conflict of interest powers (holding trustee is related to SMSF trustee).• Westpac require a corporate trustee for the SMSF and holding trust.• Meet lenders requirements BEFORE applying for the loan.
Example – Direct Borrowing PMK Repayments SMSF Funds to Loan Lender Purchase St George / PMK Family Trust Holding trustRent or “8 Victoria Ave CustodianIncome Trust” Trust’s role should be minimal . Hold property only via its trustee “8 Victoria Ave Asset – 8 Victoria Ave Custodian Trustee Pty commercial or residential Ltd” Property
Option 3 – lending options• Related party loan.• You can lend money to the SMSF from existing equity.• Dealings MUST be at arm’s length: loan arrangement must be on commercial terms interest rates must be market rates.• No personal guarantees.
Example - Indirect External lender St George PMK Repayments SMSF Funds to Loan Related lender Purchase PMK Family Trust Holding trustRent or “8 Victoria Ave CustodianIncome Trust” Trust’s role should be minimal . Hold property only via its trustee “8 Victoria Ave Asset – 8 Victoria Ave Custodian Trustee Pty commercial or residential Ltd” property
When & Why should SMSF Borrowing /Gearing be used?• High tolerance to property & gearing risk.• To control an asset like a business property which is essential to your business.• To access the property market for a long term investment earlier.• Specific financial goals.• Longer investment horizon & Understand leverage.
Risk profile• Is this your profile? long term – 7 years plus willing to invest almost entirely in growth investments see a fall in markets as an opportunity to buy in growth of 8 -13% long term.• Considerations include: time frame liquidity required falls and rises savings goals. • Commitment to long term repayments schedule.• Interest rate sensitivity.
Asset Protection IssuesWhat Happens upon:• temporary disability – break a leg• trauma – cancer, stroke, heart attack• total & permanent disability – severe injury/illness• terminal illness• death.Option 1 – sell property (may not be a good time).Option 2 – insure: who should own the insurance and how can that be arranged through the SMSF – ask us!
Other risk considerations• Inflation risk• Interest rate risk – Government needs to repay debt• Market risk – Flood of new developments• Market timing risk – Buying High Selling Low• Diversification risk• Liquidity risk – Can’t sell part of the property• Legislative risk – Not as big a risk as people thinkThese may equally apply to super (and other) investments
What to do now?• Check if you are suited to additional risk via gearing?• Make sure you do not sign anything until the holding trust is in place.• Get loan pre-approvals early.• Ensure you are using the right solicitors/conveyancers.• Take advice from professionals not mates.Call us in to take you through it.