Summary: The Government’s response to the FSI will allow SMSF gearing to continue, with a review scheduled in three years from now. But vigilance is still required as the amount of money lost through SMSF gearing is significant, usually following property-flogging seminars. Superannuation in general is set for further reform and the changes will improve the entire super system for consumers.
Key take-out: While not everyone wants to use their super fund to gear into property, the right to do so will continue to be important for many.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.
Borrowing for self-managed super funds is here to stay. For a long time.
Five years after the Rudd Government suggested a review (which was never undertaken) into the SMSF gearing rules, the new Turnbull Government has requested a report, to be delivered in three years, into the same thing.
By that time (2018), SMSF gearing will have been legal for about 11 years, after coming into force in 2007 but not really getting wings until 2010.
This is the single most important outcome for SMSFs from the Turnbull Government's response, released yesterday, to the Financial System Inquiry.
The David Murray-led FSI suggested banning SMSF borrowing as its first superannuation recommendation in its report released last year.
Remarkably, it is the only one of Murray's 44 recommendations that has been rejected outright by the Government.
All other super recommendations are being implemented, in part or in full. This will see the superannuation industry undergo further structural change, which will largely indirectly assist our national pool of retirement savings. (I will come back to these later.)
The new Government’s reluctance to ban borrowing in DIY super funds is further confirmation that the SMSF industry is – as governments have consistently stated – well run. Moreover, it is overseen largely by trustee members who play it safe, or at least understand the risks being taken, with their own money and have a good idea of what they're doing.
As for further inquiry: The government has given the ATO and the Council of Financial Regulators three years to review LRBAs in SMSFs and report back.
The Government's reasoning was partly based on recent changes to the way the ATO collects data, which has more accurately measured the extent of LRBAs in use by SMSFs (see Lifting the lid on property in super, September 23) and showed that their use is far more widespread than previously understood.
And in 2010, I wrote this column in regards to the then Rudd Government's announcement that it would review, in 2012, "whether borrowing by superannuation funds has become excessive" (see SMSF gearing safe as houses, December 22, 2010).
As stated, the review was never held. But, interestingly, with hindsight, the announcement came at the then top of the property market cycle. Property roughly peaked in 2010, before falling for about two to 2.5 years into early 2013, when the current up-cycle began, certainly in Sydney and Melbourne.
My comments then were, in effect, that it would take a property crash to have the government act to ban LRBAs. We got, roughly, a property correction at the time. And the government didn't even hold a review.
The LRBA rules, if we are to read the government's FSI response for what the words mean, would appear to be safe for at least three years. And this is good news for the majority of SMSFs.
While not everyone wants to use their super fund to gear into property, the right to do so will be important to maintain for many.
There are two important "buts" …
The first is that we should hope that the government's rejection of action should not be seen by government instrumentalities as a sign that no vigilance is required.
The single biggest threat to SMSFs in regards to geared property is property developers and spruikers. ASIC knows this and has previously commented on its concerns.
The amount of money being lost through gearing by usually new SMSF trustees into property developments is significant. The reason is, usually, because upon visiting a property-flogging seminar, the one-stop shop solution of setting up a SMSF and associated entities, rolling over funds, setting up a loan and purchasing the property, via connections to the developer, is still common.
And it is too often that the money invested into property has little, arguably no, future potential benefit to the SMSF trustee/member by way of capital growth or even solid income.
The second important point is that restrictions have already been imposed on SMSFs and their ability to borrow.
Funding for SMSF LRBA arrangements has, as a result of intervention by APRA, been heavily restricted. (APRA itself was an early responder to the recommendations made by the FSI.)
Lenders have increased interest rates for SMSF investors (in line with increases for non-SMSF investment loans) and reduced the loan-to-valuation ratio on which they are prepared to lend to SMSFs from 80 per cent to 70 per cent. In the case of AMP Bank, they have withdrawn, totally, from the lending market until at least next year. This was the only way they believed they could meet APRA's conditions of restricting investor lending growth to 10 per cent.
So, while the Government's review said nothing would happen in regards to LRBAs, APRA's restrictions have already started to bite, which will have an impact on some potential SMSF borrowers’ ability access funds.
Other superannuation responses
Superannuation in general is set for further reform, though less of it will be on the front line, or directly impact consumers. The changes are still important and will improve the entire superannuation system for consumers.
Most importantly, trustees of APRA funds will be pushed to pre-select retirement products for members. At present, in many funds, there is no natural transition from accumulation to pension phase. The government's main responses will be to encourage funds to set up a natural path for the switch into retirement income and to remove barriers to industry developing more innovative retirement products.
The government is also going to enshrine the objective of superannuation – that it is designed to provide benefits in retirement – in legislation, so that all stakeholders and decisions can be measured against the aim of super.
The Productivity Commission is also being handed a few tasks. The PC must come up with ways to measure the efficiency of super funds and review the entire superannuation system after the full implementation of MySuper.
It will also be asked to review alternatives for a competitive tendering process for default fund products. Sectors of the superannuation industry have never been happy with the setting of default funds by awards or the Fair Work Commission. The aim is to open this to competition, but already there have been screams that it could create conflicts if employers were allowed to choose default funds in all situations.
Super Choice – which many of us see as a right – is still not the case in certain industries, such as some sectors of health and education. While not naming specific sectors, the government said it will widen Super Choice to more employees.
Members will, however, start to see what sort of retirement income their super is likely to generate in retirement on their statements. Super funds will be encouraged to include in statements the projected income stream from the member's super pot at retirement.
While this will mean little to younger super members, it will give members in their 50s and 60s a better idea of what their super lump sum will provide for them in retirement.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.