How to invest in property with your retirement funds.
SMSF home loans can be used to buy property through your SMSF and give your super balance the benefit of property growth. This article will help you find out how SMSF home loans can be used to purchase property and secure your retirement. You'll also be able to compare SMSF home loans in the table below and enquire with a lender or mortgage broker to find out more.
Compare SMSF home loans in the table below
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What is an SMSF?
As mentioned above, an SMSF is a super fund in which its members (which must number less than five) direct and guide the investment strategy.
Just like a regular super fund, the 9% that represents employer contributions is still paid into an SMSF and the members can make additional deposits when they wish to, but unlike standard super funds the members or trustees are in direct control of their assets, choosing where to invest them and how the benefits will be paid out.
This extra degree of control means investments in residential property can also be added to an SMSF, meaning there's a need to find a good home loan just as in regular property purchases. Since superannuation rules changed in 2007 to allow Australians to borrow and purchase property through their super funds, many lenders both small and large now offer loans specifically for this.
Like any financial product, always seek professional advice from a mortgage broker or accountant before making any decision.
What are the features of an SMSF?
Setting up an SMSF is much like setting up a trust. The difference is you need to set it up according to specific rules so that it complies with the laws and regulations that apply to these types of funds. In other words, it has to be established and run as a fund that has the sole purpose of ensuring the members have access to retirement benefits. The list below describes some of the most critical features of an SMSF:
Tax benefits of an SMSF
Owning and running your own SMSF can have some considerable tax benefits. However, it's important you understand how your SMSF is taxed first before you try to create an investment strategy based purely for tax purposes.
The tax on income derived from a superannuation fund is usually 15% for a complying fund and 45% for a non-complying fund. The tax you'll need to pay on income produced from an SMSF differs depending on the type of income it is. For example contributions without a Tax File Number (TFN) are taxed at 46.5%. You might also be taxed more if you are notified that you aren't complying with superannuation fund rules or if you are earning income from any other investments you have not connected to the super fund.
Capital Gains Tax
Capital gains tax is charged at 15% if you sell the property while you're still accumulating your super, and if you hold onto it for a year it will attract capital gains at the rate of 10%. If you sell the property when you're receiving your pension you'll be exempt from paying capital gains tax.
What are the steps for setting up an SMSF?
There are certain things that need to be done when creating a self-managed super fund. There are regulations and legislation which SMSFs need to comply with when they are being set up. There are also ATO requirements in terms of reporting, like with any new entity.
So, if you are thinking of setting up a fund so you can manage your super contributions, then you have to:
- Pick a name for the SMSF and seek professional advice from an accountant, who can help you with choosing the right trust and trustee structure;
- Put together a strategy for investing;
- Submit applications to get the trust regulated as well as to get your Tax File Number and Australian Business Number, which can be done at the same time;
- Choose a bank to open an account. Have certified copies of the trust deed that's already been signed, the tax file number and business number certificates, as most banks will ask for them before they let you open an account.
- Get in touch with the superannuation fund you were using until now so that they can transfer your current balance. This process can take up two months but it can be done as quickly as two weeks. The public fund will likely request certified copies of the trust deed as well as a letter from the trustee.
Some of these steps can be a bit complicated, so it could be wise to seek the advice of a solicitor or accountant.
Buying a property through your SMSF
As mentioned above, since 2007 Australians have been able to purchase many different types of property through their SMSF. By using your SMSF to borrow money you can invest in residential properties, commercial office space, warehousing, showrooms, shops, factories and even certain residential development projects, if they have been approved. According to statistics released by the ATO in 2011 3.5% of SMSF funds had invested in residential property, while a further 11.4% had invested in non-residential property.
Just like a regular home loan however it's always a good idea to shop around, and in particular look at smaller lenders outside the big four. Thorough research and a good mortgage broker will present you with a variety of options and guide you in choosing one that is suitable for your current situation.Borrowing with an SMSF differs slightly from regular home loan borrowing, so it's sometimes a good idea to seek advice from a mortgage broker or find out about any SMSF training your lender may be offering. The main difference being that an SMSF mortgage is more difficult to process, with fines of over $200,000 applying to trustees if their arrangements aren't properly structured.
How do I purchase a property through my SMSF?
The process of purchasing a property through an SMSF is similar to a regular property with a few key exceptions, and each lender will have their own restrictions in regards to certain features of the loan.
St.George Bank for example - one of Australia's biggest retail and business banking brands with over 2.6 million customers, offers investment loans specifically tailored to SMSFs. This particular product can only be used to invest in residential properties, or refinance an SMSF home loan.
The process is generally the same for each different lender, with the main processes being:
1. You create your SMSF with the help of your accountant, who can also advise you of the benefits of investing in residential properties via your fund.
2. Identify the property you wish to purchase. As with any investment, take your time and consider every aspect carefully, including potential capital gains, rental income and market value to name just a few. After all, you are looking for a property that will make a profit and, hopefully, one that would be able to cover the repayments of the loan from its rental income alone.
3. Decide who will act as a custodian for the property. The custodian holds the property title on your behalf until the loan is paid off, otherwise known as a 'bare trustee'. This will need to be noted in writing, and the custodian is sometimes required by your lender to be a company.
4. You submit the home loan application along with all the required documentation, some lenders will do a liquidity test of the SMSF to make sure that it can service the loan once the property purchase is complete.
5. The custodian issues payment of the deposit and contracts for the purchase of the property are exchanged.
6. If the loan is approved by the bank, the custodian puts the property up as security with the lender so the transaction can be finalised.
7. You cover the costs of stamp duty and legal expenses.
8. Upon settlement of the loan, you begin making repayments and cover other day-to-day expenses on the property as well as collecting the rent. If rent doesn't cover the repayments the difference will need to be made up through your SMSF contributions.
9. Once the loan has been paid off, the title can be transferred to the SMSF from the custodian or the property can be sold off.
Application times for SMSF home loans
Using an SMSF to take out an investment loan is quite a bit more complex than submitting an application for a standard home loan. Generally, you'll find that it might take you about a week to gather the paperwork you need for the application and take your lender at least another week to evaluate and accept the pre-approval application.
Are my other super assets at risk if I default on my loan?
By law, you're generally only permitted to purchase an asset with your SMSF using a 'limited recourse borrowing arrangement' (LRBA). This means if you default on your loan, your lender cannot seize any of your other SMSF assets - only the asset that is the object of the loan. Any other assets your SMSF owns are protected. This type of loan comes with drawbacks - namely less flexibility than a regular home loan, and limits to how you can deal with the purchased property which are explained below.
Some banks might require the members of the fund to provide guarantees, but these will be structured in such a way that the guarantors can take no action against the trustee of the fund if the SMSF defaults on the loan. There are lenders however that will not ask for a personal guarantee from the fund's members.
Restrictions on an SMSF property
There are some restrictions when it comes to any property bought by an SMSF, namely that you can't construct a new home, nor can you live in the home at any stage until you're in the pension phase.
Note that if the purchase is for your business, this is acceptable. While you can't sell a residential property to your SMSF if you or someone close to you owns it, you can do it with a commercial property.
Renovations and repairs are also a complex area in regards to SMSF properties:
- You can renovate and repair your property, although this comes with conditions regarding how you finance these activities.
- Regular maintenance on a property such as fixing leaking taps and other general running costs come with no legal problems.
- Carrying out significant improvements on your property are usually not able to be financed your SMSF loan, as it must be used for the initial investment it was intended for and not to purchase new investments such as a home extension.
- Using funds from your own pocket rather than your SMSF to finance a renovation is another tricky area. Funding renovations with money from outside your SMSF could make tax time tricky for you as you could then personally own some of the property while your fund owns another portion.
- Alternatively, contributing more money into your fund to finance the renovations could also bring with it challenges as there are strict limits on how much you can contribute to your super each year.
- You can seek a private ruling from the ATO to decide whether the work you're carrying out will be considered a significant improvement or part of normal maintenance. This gives you the backing necessary to help you follow the correct process.
- A specialist SMSF advisor along with an accountant can help with these matters.
Which banks have loans for SMSF trusts?
SMSF home loans are available from a range of small and large lenders, including some of the big four banks. Because they have much more complex document and compliance requirements, not every lender will offer an SMSF home loan. Some of the lenders currently offering SMSF home loans include:
- Macquarie Bank
- Commonwealth Bank
- Beyond Bank
- Big Sky Building Society
- Yellow Brick Road
You can compare some of the lenders and home loans available through an SMSF by looking at the table above.
Which lenders require a liquidity test of your SMSF when processing a loan application?
Self-Managed Super Funds are set up to become an income stream once you retire so some lenders will do what is called a liquidity test. This is a test that judges how much liquid assets or accessible funds will be in the SMSF once the purchase is complete to make sure the loan can be serviced by the fund.
Below are a list of lenders who offer SMSF loans and whether they do liquidity tests:
- AMP SuperEdge Loans
- Big Sky Building Society AMSF Limited Recourse Investment Loan
- Commonwealth Bank SuperGear
- Homeloans Classic SMSF
- Macquarie Bank SMSF Loan
- St.George Super Fund Home Loan
- Westpac SMSF Investment Property Loan
Tips to consider before setting up a SMSF
There are a lot of factors to consider before you establish an SMSF. You need to do plenty of research and think it through thoroughly. First of all, you need to make sure that an SMSF is really what you need. The easiest way to do that is to consider the following questions and issues:
Questions to ask
- Is it cost-effective? Managing an SMSF can be quite expensive since there are a lot of fees involved. Analyse the level of retirement savings you have and decide whether it makes sense from a financial standpoint to establish an SMSF. A good place to start is to look at how much auditing an SMSF costs compared to what standard retail super funds charge, which is 1-2%.
- What advantages will you be giving up? Generally, super funds provided by employers tend to come with a wide range of options and advantages, such as cheaper life insurance. To get these advantages with an SMSF, you will likely have to sort them out yourself.
- Can you invest the funds effectively? You really need to be objective regarding your investment knowledge and skills because a public fund has an army of specialists and experts devising and implementing investment strategies. So, if investing really isn't your thing, you aren't going to be gaining any additional benefits in terms of returns by managing the fund yourself. An SMSF is usually a good option for people with a decent level of experience in investing.
- Will you lose money? If the fund starts losing money, there's no way to get it back. Public funds, however, offer compensation.
- Do you have all the information you need and do you have time to manage the fund? Running an SMSF is complicated. Firstly, you need to be fully aware of all the laws, rules and tax regulations that govern an SMSF since you have a wide range of criteria you need to meet to qualify as an SMSF. You also need to have a good understanding of investing and the financial markets. If you think you aren't suited to managing your fund effectively, then you should seek out professional advice from an accountant who specialises in SMSFs. Keep in mind that no matter how great the advice is, the trustee is still the one responsible for the success or failure of the fund.
When establishing and operating a SMSF, there are certain things you should keep in mind:
- Administrative duties must be carried out, including but not limited to taxation and record keeping;
- Perform audits as the ATO requires them;
- Make sure you keep good records of everything and prepare all financial statements;
- Be fully aware of all the legislation governing SMSFs so you can be certain you are in full compliance with all ATO and government regulations;
- Always get professional advice before committing to any commercial or financial agreements on behalf of your SMSF;
- Make sure you meet all conditions before you take advantage of the benefits of your SMSF as it is illegal to draw funds from your fund before retirement age. Doing so can lead to significant penalties for the fund and the member in question.
Buying property through an SMSF is a popular method of increasing the potential size of your super. There are many different considerations you should make before both opening an SMSF and using it to invest in property, so ensure you have a professional who is knowledgeable enough in the area to steer you clear of any pitfalls.
Have you considered SMSF life insurance?
If you're interested in taking out a SMSF home loan, it may also be worth looking into whether it is worth taking out SMSF life insurance cover. SMSF life insurance can be an attractive option for those who are interested in funding their cover through their superannuation as oppose to their take home income. SMSF life insurance is becoming more and more popular among Australians though there are some restrictions to be aware of including reduced number of types of cover to take out and the taxation of premium payments.