Self Managed Super Funds “SMSF’s”
More than 30% of the $1.4 trillion in funds under management in the Australian superannuation industry is now in self-managed super funds.
What are must know things for investors considering SMSF’s and property in SMSF’s?
The introduction of compulsory superannuation was recognition of the crisis in pension funding that is looming as the population ages. The subsequent legislation to allow SMSF’s to borrow to purchase property only is recognition of the relative predictability and reliability of bricks and mortar as an asset class.
There are huge monetary advantages to owning property in an SMSF, including no capital gains tax after 60 yrs of age and no income tax after 60 or 55 if in ‘pension phase’. SMSF’s provide many people with the chance to control their own hard earned income and lucrative incentives to be self funded in retirement. The need for expert and specialized advice is so important as is the need for review and adjustment as you reach significant age thresholds, the assets are paid off or incentives change etc., When purchasing a property in their SMSF only single contracts are permitted. Stamp duty is payable on the completed purchase price and there are no ‘draw downs’ on the loan for new homes. Property can still be negatively geared in an SMSF. In other words all the costs of owning and maintaining the property are tax deductible and offset against the rental income. Any shortfall will be rebated at a tax rate of 15%. Because tax benefits aren’t as significant in an SMSF it’s important that the property will be serviced wholly within the fund. Avoid being ‘shoe horned’ into a property to then find that the SMSF has insufficient funds to cover all ongoing expenses – it’s important to keep the gearing level conservative.
Borrowing to purchase a property inside your fund does not affect your capacity to borrow outside the fund. So it may be in your best interests, depending on your current circumstances, goals and age, to hold a property outside your SMSF too.
Who is eligible to set up an SMSF (how much is required)?
In order to maintain conservative gearing levels, anyone with $100K or more in their fund(s) may be in a position to do so. The funds might come from rolling over a number of small balances belonging to one person or combining the joint accounts of a couple, or even a group of people with common purpose. Borrowing capacity does depend on contributions too so that’s why it’s a “may be” and not a guaranteed entry point.
There are exceptions to the rule. For those who have low super balances but have unused equity in their home, a “related party loan” can be made to the SMSF to provide funds to purchase a property inside the fund. The SMSF then pays the repayments on the loan. Therefore there really is no definite figure required to set up an SMSF, it needs to be assessed on a case by case basis.
How difficult is it to set up an SMSF?
The legislation governing SMSF’s is complex and there are heavy penalties for non compliance. Legislation can also change and so anyone considering setting one up should be wary of the ‘transaction focused’ service providers who happily set up SMSF’s, facilitate a property purchase and then walk away with no ongoing management or reviews.
Who might consider sticking with a retail fund?
People with low balances, low incomes and with insufficient or no available equity are probably better off sticking with their existing retail fund. Borrowing to invest in property in an SMSF is not only a function of available deposit, it’s also dependent on the regular contributions to the fund because the fund is a self sufficient entity, it needs to have enough coming in to cover all the ongoing costs of a property beyond what the rent will cover.
Are there any common pitfalls?
If your SMSF isn’t set up correctly to start with you could have your hands tied for years until you can build up sufficient funds to buy again. For example it’s not strictly possible to access the equity in a property held in an SMSF to purchase another property but one bank is now offering an offset account inside the SMSF. This reduces the interest payable on the property making outright ownership happen sooner but the “equity” held in the offset account can be used to purchase again.
As there are significant tax advantages to owning property in an SMSF, understandably the ATO imposes significant penalties for what it deems as ‘non compliance’. All is easily averted though by seeking expert and qualified advice. Ask to see the Australian Financial Services Licence of any planner you are introduced to.
In terms of the property selection it’s important not to make emotional decisions. The property is an investment ‘vehicle’, it may not be your dream home but does it meet the demands of the rental market and does the area have long term growth potential? You need to rely on expert advice to identify the above average opportunities in the market based on economics drivers, population growth, government plans etc.
Properties need to be chosen that are ‘sustainable’ for the long term and because gains are only realised when the property is sold there needs to be an exit strategy. That might come down to simple considerations like buying under or around the median price and considering the changing demographics of an area in order to maximize market size when it comes time to sell.