Government says you can borrow, but beware
The Financial System Inquiry may have thought borrowing within super to fund property investment was too risky, but the government disagrees … for now.
- Borrowing within super on three-year parole
- Leverage deemed acceptable, at 2.5% of SMSF assets
- Strategy requires very careful contemplation
If you haven’t decided exactly when you’ll want to retire, but feel pretty comfortable that it will be at least a decade or so away, should you worry about taking a few risks if it means you might boost your balance?
That’s the logic which leads some trustees of self-managed superannuation funds to not save in super, but borrow.
It’s a strategy that sounds risky right from the start, but if the intended investment is property then most Australians’ minds are put at ease. The asset class is a national favourite – almost an obsession – and strong price growth is all many generations of Australians have experienced.
But borrowing within superannuation is obviously unusual, because how can debt be turned into income when the time comes? Only if the loan is paid down and the asset appreciates in value. If investors expect the growth in property values of the past couple of decades to extend into the future, they may be disappointed.
The property paradox
This risk in borrowing within super was acknowledged in the Financial System Inquiry, which recommended that limited recourse borrowing arrangements, or LRBAs, be banned for self-managed super funds.
DIY super funds favour LRBAs as lenders do not have recourse to other assets within the SMSF in the event of a default by the borrower. Lenders and borrowers tend to favour much shorter term loans for property in super than private borrowers demand for residential property, where loans last as long as 30 years. This is most likely because SMSFs where the trustees are business owners have been buying commercial property and then leasing it to themselves.
But the nearly $600 billion accrued in Australian SMSFs has attracted salespeople keen to convince trustees of the benefits of borrowing to by property, so long as these spruikers can take a clip along the way.
Where the government set out on compulsory super in the first place to save itself having to pay us all full pension in the future, any threat to individuals’ savings would be taken seriously.
That’s what the Financial System Inquiry may have thought, but in October the government announced in its response to the inquiry that it would not accept the recommendation to ban most forms of super fund borrowings, including SMSF LRBAs.
“While the government notes that there are anecdotal concerns about limited recourse borrowing arrangements, at this time [it] does not consider the data sufficient to justify significant policy intervention,” its response said.
Maybe on closer inspection the risk in LRBAs looked a bit too marginal. In its quarterly SMSF statistical report for June, the ATO estimated $15.1 billion in assets was held under LRBAs, or about 2.5 per cent of the total assets in DIY super. Still, where there’s smoke…
The government has promised to keep an eye on borrowing in super, and it has tasked the ATO and the Council of Financial Regulators to keep track of leverage within SMSFs and report back in three years.
By then interest rates may have risen and the property market may have cooled. DIY funds already paying mortgages on property will be closer to paying down principal.
The option to borrow in super may be kept open, but the strategy requires careful thought.
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