With an addition to the Superannuation Industry (Supervision) Act 1993 in September 2007 self managed super funds are now allowed to borrow money, meaning your super fund can own an investment property which grows in value for your retirement.
Your self-managed super fund selects a property, sets up a security trust and then takes out a specialised self-managed super fund loan. The beneficial title of the property is held by the fund, while the legal title is held on trust by an independent property trustee. The deposit for the purchase of the property comes from your self-managed super fund as do the mortgage repayments to the investment loan. When the loan is repaid in full, the asset and title are transferred to the fund, or the property trustee can continue to act as the registered proprietor.
A self-managed super fund can borrow money if all of these conditions are met:
- The money is used to buy an eligible asset.
- The asset is held in trust so the fund acquires a beneficial interest in it.
- The fund has the opportunity to acquire ownership of the asset by making payments after having acquired beneficial interest.
- If the fund defaults on payments to the lender there is limited recourse as the rights of the lender are limited to the asset.
As with most types of investment loans, your self-managed super fund repays the borrowed amount as the equity in the property grows. Plus, all ongoing costs related to the investment are paid by your fund, and the fund has full control over renovations, leasing, selling and collecting rent. Self-managed super funds are the largest and fastest growing part of the superannuation industry with the total number of self-managed super funds revealed to be around 422,687 in a recent ATO report at March 2010 with an estimate of $12.8 billion of residential property assets and $43.6 billion of non-residential assets held.
What are the benefits of self-managed super fund property investments?
If you’re looking to get more out of your self-managed super fund or you’re considering having a self-managed fund set up so you can have more control over your retirement payout, then consider whether you can benefit from:
- Tax concessions. There are a number of tax concessions available to self-managed super funds which own property, including a maximum capital gains tax charge of 10% if the property is owned for more than 12 months, and potentially no CGT if the property is sold during the pension phase. There is also a minimum tax of 15% on the property’s rental income and expenses including interest, council rates, insurance and maintenance can be claimed as tax deductions by the fund.
- Greater control over your investment’s future. By gearing the property, your self-managed super fund can acquire property which is worth more than the fund’s net worth.
- Limited recourse. Apart from the property your fund buys, all other assets are untouchable by the lender in the case of default.
How do you avoid the pitfalls of super fund investments?
Before having your superannuation jump into the property market, make sure you know and understand the possible drawbacks, and how to avoid any pitfalls, such as:
- Trustee power. Your self-managed super fund trustee holds all the power over the investment and also carries full responsibility. This means that because complying with super and tax laws is your responsibility, if your trustee does not meet the conditions, their non-compliance could result in fines or imprisonment.
- Restrictions on self managed super fund loans. The loan products available for use by self-managed super funds can often be very restrictive, with fewer features and the option for a fixed or a variable rate only. A lower loan to value ratio is allowed and so a higher than average deposit is required. Redraw and post-settlement loan increases are also not allowed.
- More complex property investment. Getting finance for self-managed super fund investments is more complex than standard investment property finance and the biggest hurdle is that most people don’t have enough super to purchase property with. You will need a super balance of at least $120,000 to consider investment through your fund as more financial input is required.
- Low loan to value ratio. With a $120,000 super balance you be allowed just a 70% loan to value ratio meaning your super fund can borrow just $399,600. The highest LVR available on any self-managed super fund loans is around 80% and usually the loan is structured so the property is geared to a level where it provides positive cash flow – that is the rental income covers the loan repayments and maintenance costs.
- High set up costs. To set up a property purchase through a self-managed super fund will be higher and the ongoing costs to the fund will be around $2,000 per year for a medium sized fund. This means your fund needs enough money to set up and service the loan as well as for these ongoing administration costs, not to mention the out of pocket costs if the property is negatively geared.
- You cannot live in the property. As a member of the owning self-managed super fund you are banned from occupying the property. At the time of retirement the property can be transferred to you so you can live in it then.
- No refinancing. Once your fund opens an investment loan account no refinancing is allowed so make sure you are getting the best deal from the beginning.
Steps to Self-Managed Super Fund Investment Property
If the benefits of using your self-managed super fund to invest in property outweigh the drawbacks in your situation, then you need to follow just a few simple steps to set up your investment and take control of your retirement:
1 – Work with the experts
While superannuation and investments may sound simple enough on their own, when combined you will need to make sure you are working with industry experts who can ensure your investment potential is maximised, and your fund is compliant with all super and tax laws. You can find a super fund administrator or a financial planner to help you manage your fund, as well as a solicitor experienced in the area for advice on the legal structure.
Be aware too, that as of 26 April 2010, the federal government announced an amendment to the laws which states that accountants are no longer able to offer advice about the establishment of self-managed super funds.
When deciding whether a self-managed super fund is right for your situation:
- Seek professional advice.
- Make sure you have enough assets, time and skills to manage your fund.
- Abide by the super and tax laws so you understand the risks.
- Make sure your trust deed and investment strategy suits the members of the fund.
- Abide by your record keeping and reporting obligations.
- Understand your annual auditing obligations.
2 – Set up your fund correctly
For this step you should enlist the help of a self-managed super fund specialist to help with the set up. Alternatively you can work with the network of experts you already have and have your solicitor draft a trust deed, your accountant or administrator organise the paperwork and a financial advisor who can help with the investment strategy. The costs for this advice can range from a few thousand dollars to tens of thousands of dollars so shop around for the best deal. Annual fees can also vary, but expect to pay between $1,000 and $2,000 for and annual audit and administration.
Next you will need to appoint your trustees and an individual trustee super fund is made up of one to four members, each of whom is a trustee. No member is allowed to be employed by another unless they are related and trustees cannot be paid for their trustee duties. Each trustee will sign a declaration and will have specific duties including appointing an approved auditor, and ensuring the fund meets the sole purpose test of providing retirement benefits to its members at all times.
Your self-managed super fund then needs to be registered with the ATO once all trustees have signed a trustee declaration. The fund will need an ABN and tax file number, and be registered for GST if the annual turnover is more than $75,000. Once the fund is established you are legally required to lodge an annual tax return, pay a supervisory levy and have an audit report prepared.
You will also need a dedicated bank account for your fund which separates fund assets from your personal assets for account keeping and administration purposes. The funds in this account will pay all self-managed super fund bills, the loan deposit and repayments, plus all rental expenses. You will also need to keep a record of each member’s entitlement, recording member contributions and benefits paid.
3 – Have an investment strategy
Your self-managed super fund investment strategy is a set of rules which determines how the trustees intend to invest the funds and distribute the funds on behalf of the members in order to create wealth. The plan must include actionable strategies to maximise member benefits.
4 – Obtain pre-approval
As with any property search it is best to start with a pre-approved loan, which can be done once the legal structure for you fund is in place. Pre-approval also helps you avoid excess costs and if you do this before structuring the legal aspects of the fund you’ll know that you are clear to go ahead.
5 – Choose a property
The trustees have the power to choose a property and it can be residential or commercial. To be eligible for purchase the property must pass the sole purpose test, being an established property because houses under construction and vacant land are prohibited. The property must also be purchased from an arm’s length vendor not a related party, and trustees may not occupy either residential or commercial property bought.
6 – Finalise a security trust
With pre-approval you can finalise the legal structure and establish a property trust which allows the property trustee to hold the legal title of the property until it is repaid in full. You will need to choose a property trustee, one who is not a fund trustee. Also make sure the property trust deed is correctly prepared to avoid tax or stamp duty issues.
7 – Obtain formal loan approval
Once your loan is formally approved the structure is then reviewed by your lender’s legal department where around 60% of legal structures are found to be incorrect. Therefore, avoid delays at this step by having everything reviewed and in place correctly beforehand.
8 – Settlement
Once contracts are exchanged between the self-managed super fund and the vendor the settlement period begins and the fund will need to pay a deposit to secure the property. The legal costs and stamp duty for the purchase will also need to be paid at this point. The loan documents are then prepared and sent to the fund’s conveyancer and once the loan documents are issued, settlement is reached.
9 – Manage the investment property
All associated bills for the property are paid through the fund and the property is managed in the same way as a personal investment property. The trustees have full control over renovations, leasing and the decision to sell, and rental income is paid back into the super fund.
10 – Obtain legal title
Your self-managed super fund can pay out the full loan amount at any time, although you may incur lender exit fees for early termination of the loan. Once the loan is paid out, the property trustee can continue to act as registered proprietor, or legal title can be transferred to the fund, which will be both capital gains tax and stamp duty free.
If the property is kept until the pension phase of the fund, there is no capital gains tax payable and if you want to live in the property during your retirement you can purchase the property from the fund. You will need to able to fund the purchase yourself while the cash for the purchase can be taken from your fund, you will need the funds for a few days between the processing of the sale and transfer.