With the Royal Commission putting superannuation arrangements under the microscope, as well as many of the big four banks pulling out of the SMSF borrowing market – it begs the question is borrowing in superannuation a relevant and viable strategy?
The Royal Commission has shown us that borrowing rules have been too relaxed, and now, this is no longer the case. The major banks who have pulled out of the market, are mainly affecting the residential space. The financiers who are left are tightening their credit requirements and are taking much longer to approve loans.
The credit terms on offer are stricter in a post-Royal Commission world. Some financiers expecting no less than $250,000 in net assets, a 10% liquidity requirement and proof of a consistently high level of ongoing contributions in order to supplement rental income received. Property valuations, performed by the financier, must match the purchase price of the property or financier can walk away from the deal, rather than allow the purchaser to top up the difference. This can present a risk for potential buyers, particularly in a market where property prices are volatile.
With any gearing strategy, there are multiple risks to consider. Lack of diversification is one of them. If you only have property and cash in your portfolio come retirement, how is the fund going to afford pension payments plus all of the outgoings for the property? With gross rental yields just under 4% for capital cities combined (unless there are significant other holdings) it’s going to be difficult for a fund to pay out 4-5% of the fund balance as a pension in retirement as well as the compliance costs of the fund.
Apart from the risk that borrowing poses to retirement planning. There are still the usual investment risks to consider. Ensuring the fund has sufficient liquidity to pay the debt should the property become untenanted. Market timing risk if the property needs to be sold at a low point in the investment cycle. Liquidity risk if the property needs to be sold quickly.
Trustees need to understand that there are restrictions to the investments an SMSF can borrow to invest in and it is essential that all investments are conducted at arm’s length. The limited recourse nature of borrowings in the SMSF environment often sees trustees exposed through personal guarantees over their personal property assets.
The Government can’t seem to leave superannuation alone, with an upcoming election, federal budget and post-Royal Commission recommendations yet to be implemented, we could see a variety of changes on the horizon. The risk of legislative change could see the strategy become ineffective.
Is borrowing in super still an effective strategy to build wealth for retirement?
Enhancing your retirement savings through a gearing strategy may still be an effective way to build wealth, but it needs to be done with caution. Maybe you don’t have sufficient assets outside of super and want to invest in property, or you are a business owner who wants to buy business real property to house your business premises.
It is a tax effective strategy as tax deductions are generally available for interest and other borrowing expenses and these deductions can offset other earnings in the fund.
Before you consider borrowing in your SMSF have you considered:
There is no doubt that Australian’s are comfortable with property investment but many people fail to consider the depth of the risk of using their retirement savings to do it.
For a gearing strategy to be effective over the long term, the trustees need to be willing to take on the risks of a gearing strategy and be confident that the potential for increased returns outweighs the risks of borrowing in super.
This article touches on some of the risks and considerations of a gearing strategy and is not by any means an exhaustive list. The SMSFs and Property page of the ASIC Smart Money website provides a place to start understanding of the rules for purchasing property in an SMSF.
Borrowing in superannuation is a complex area that requires professional advice to consider your personal and financial situation in depth. The advice in this area is crucial and the strategy should not be implemented without proper due diligence.
Author: Simone Murad