PORTFOLIO POINT: Property gearing in SMSFs seems to be here to stay, but beware. Plus: Roger Montgomery, I accept your challenge.
At the time, it was one of the biggest surprise decisions to have ever occurred to the superannuation industry.
In September 2007 – nearly six years ago – the rules were changed to allow borrowing within SMSFs. No-one saw that coming (like the recent FBT changes). The entire industry thought the opposite would happen – that gearing would be shut down by the ATO.
And it is now more than 2.5 years since the government agreed it would review “whether borrowing by superannuation funds has become excessive” (see 22/12/10).
That review was due at the end of last year, but it would appear no public or private review ever took place. Certainly nothing has ever been published.
And, as I wrote in that piece on 22 December, 2010, it was unlikely to happen unless (or perhaps until) we had a property crash.
There was no crash, but it is interesting that late 2010 was the peak of the national property market. From there it went into a gentle decline until earlier this year.
Depending on what series of data you follow, the falls were around 10%. Add in a few years’ inflation and property prices went backwards by about 15% or so in real terms.
So, for many, property is looking cheap.
But there’s further appeal.
Interest rates are at historic lows. The penalty interest margin charged by banks for SMSF property deals has evaporated. The standard variable rates for SMSF property loans are now around 6.2%, which is about half a per cent more than what the average homeowner pays. When gearing first started, the gap was around 2%.
You can see why some Generation Ys are complaining about having to not only compete against each other and property investors, but now SMSFs also.
Everything seems to be hotting up for property in super. But the warning bells in some areas are beginning to ring louder and louder.
The number of warnings coming from the Australian Securities and Investments Commission is actually surprising. ASIC is specifically concerned with the number of dodgy property development companies, and their usually tied-in promoters, flogging unsuitable property on unsuitable candidates.
Unsuitable candidates are those who previously knew nothing about property but are lured by potential returns and those who do not currently have a SMSF.
Thousands of Australians have been lured to seminars run by property developers with the promise of a one-stop shop for buying investment property in their SMSF, including finding the property, setting up the fund, organising the loan and leasing agents.
And how many of them are related parties? Far too many.
Often, ASIC publishes these warnings in a press release, does a few interviews, then goes about quiet investigations. But not this time. ASIC is in the media on a regular basis warning. And they’ve had a few recent wins, including a three-year ban on a high-profile Melbourne real estate agent.
My advice remains the same. Unless you understand property investment outside super – and preferably have owned geared property outside super for several years – you should not be getting into geared property in SMSFs.
The structure is crucial. Making sure you have properly worded trust deeds and understand the correct structure are areas that are crucial. Getting these things wrong in a SMSF can lead to funds being declared non-compliant by the ATO, which can lead to devastating fines and tax consequences.
Can’t agree with you, Roger
Colleague Roger Montgomery would appear to be no fan of superannuation. Roger recently commented (not in Eureka Report) that anyone under 50 should only invest the bare minimum in superannuation.
“What I am not saying is that you shouldn’t invest. You must invest, irrespective of your age. What I am questioning is the wisdom of investing through a structure that may not be as tax effective, nor may your funds be as accessible, in the future as it appears today,” Roger said.
“Ignore the calls to save tax and boost your super, you will be soon contributing 12% of your salary anyway. This is not advice but a challenge to others, much more qualified than I, to dispute it and explain why I am totally wrong,” he said.
Roger, I accept that challenge.
I could write a book about why I believe he’s wrong. But I’ll keep this brief.
Roger’s main concern is that as the superannuation pool grows, it will become irresistible to governments to tax more heavily.
Perhaps. Even likely. But super will never be taxed as heavily as non-super money, even if governments get desperate. Taxation on super might be increased, but it is highly unlikely that it will ever be taxed at marginal tax rates.
Those lower tax rates compound in super.
If you earn $120,000 a year, on the last $10,000, you would get to keep $6150. If you put it in super, $8500 would go into your super fund. That is, you get to keep an extra 38% if you put it into your super fund to be invested.
If the $6150 is invested outside super, it will be taxed on its income at 38.5% and taxed on capital gains at 19.25%.
In super, the $8500 will be taxed on income at 15% and 10% on capital gains.
But that’s only until you’re 60. Then the tax rates for super become 0% when you turn on a pension. (That’s under current rules, which, as Roger points out, could change.) Assuming they are sold after 20 years when our investor has turned 60, the super fund’s $8500 would have grown to a figure 78% higher than the $6150 had grown to.
Don’t pay anything more than the minimum into super before you turn 50? I’ve spent years arguing that you need to start contributing more to super from about 40 (including this two-part column, 23/2/11 and 2/3/11).
It used to be 50 that you started loading up on your super, but 40 has become the new 50 for superannuation, because of massive actual and real cuts to concessional contribution limits. If you don’t start contributing more earlier, you will get to a point sometime after 50 when the kids are off your hands and the mortgage is paid down, but you simply can’t put more money into super because of the lower contribution limits.
You don’t put everything into super. In your 40s, you need access to cash. But putting in a little extra from about 40 is an imperative. The shift to Superannuation Guarantee contribution rate of 12% is still not enough.
But if you don’t believe in putting your investments inside super, Roger, thank you. I’m happy for others to pay more tax than they need to, particularly if they do so deliberately. It will reduce the pressure on the rest of us who want to minimise their tax.
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.