(03) 9020 2905PORTFOLIO POINT: Loans in super funds can be “forgiven” – a handy way of getting assets into a fund now and benefiting from the low-tax super environment.
A starting point for all lending seems to be loan to valuation ratios (LVRs), which are a yardstick measure for how much a particular lender will agree to lend against a given asset.
Those who have borrowed outside of super for property will know that it’s possible for individuals to borrow up to approximately 106% of the cost of a property (for example, borrow $530,000 for a $500,000 property), if the individual has other property assets to put up as security to the bank.
If a non-super property is geared without the security of other property, lenders will usually restrict the borrower to 90% of the value of the property. In that instance, the borrower would have to come up with, roughly, the 10% deposit, plus the 6% in stamp duties and costs.
As you’ve probably heard me and others yabber, the rules for lending inside super are different.
The biggest of the differences is that a SMSF loan must be limited recourse. In essence, the lender may only come after the asset that it lent against in order to have the loan repaid. If a loan of $400,000 was given for an asset, but the asset must be subsequently sold for $350,000, the lender will have to take a haircut of $50,000.
Because of the limited recourse nature of the lending, banks will usually restrict their lending to an LVR of around 70%, particularly when it comes to property. That is, most banks would only lend $350,000 against a property worth $500,000. That way, the lender’s interests would be safe with a forced sale at up to a 30% decline.
Banks have to look after their capital on behalf of shareholders.
However, if YOU become the lender, you don’t have to play by quite the same rules.
As I’ve discussed previously (see 21/4/10), you can become the lender to your own super fund. And while you still have to make the loan under a limited recourse agreement, you don’t have to restrict the LVR to your super fund.
If you want to lend your super fund 100% of the dough in order to enter an investment, then you can. (Don’t forget you still need to make sure the loan is housed in a bare trust within the super fund, has proper loan agreements, etc.)
If you personally would like to lend your super fund $2 million to purchase $2 million worth of assets, then there’s actually nothing in the super borrowing provisions to stop you doing that, if you follow the rest of the rules.
But you can also lend in assets. That is, you could make a loan of shares or property to a super fund (although residential property is banned).
Why might you make super-sized loans to your super fund?
Predominantly, to get assets into super and out of your personal domain, where they will be taxed at your marginal tax rate.
By getting assets into super, you’ll get access to a maximum tax rate of 15%, but potentially 10% or even 0% for funds in pension phase.
Take a $2 million commercial property, or a four $500,000 parcels of shares (such as BHP, CBA, Wesfarmers and Woolworths. I realise that’s not a particularly diversified portfolio, but recent murmurs from the ATO suggest they want loans must be against a single asset. A single asset can be 10,000 BHP shares, but a 10,000 BHP shares and 10,000 CBA shares are two separate assets. The belief now is that they would have to be housed in separate bare trusts.)
How is the super fund going to pay back the loan?
Sure, you could use a traditional way of a principal and interest loan agreement. But that would take all of the fun out of this week’s column.
While the super fund will need to make interest payments (the terms of the loan can be interest-only if required), the super fund doesn’t necessarily need to physically repay the principal. The loan can be “forgiven”.
If a couple were to make a $2 million “loan” to a super fund made up of large parcels of shares, the loan could just be forgiven over time. The forgiveness would then need to be considered as non-concessional contributions.
For example, on the $2 million initial loan, the couple could potentially forgive up to $150,000 worth of loans, EACH, per year. And, they could potentially forgive up to $450,000 each under the pull-forward provisions.
The $2 million loan could, at the last day of the 2010-11 financial year, be reduced to $1.1 million with a few swipes of a pen, if both members of the couple decided to make $450,000 non-concessional contributions to super.
(They would have to be eligible to make non-concessional contributions, of course.)
That would wipe out the members ability to make non-concessional contributions for the remainder of the FY2012 and FY2013 years. They would again be able to make another contribution, if eligible, of a joint $900,000 in the FY2014 financial year to cover them for that year, plus the following two.
Why not just sell the shares and put the money into super?
You’d be restricted as to how much you could get in to super, again by the non-concessional contribution rules. You would only be able to get $900,000 in as a cash non-concessional contribution into the fund, or potentially $1.2 million, if both couples made a $150,000 contribution in the current financial year, then did a $900,000 ($450,000 each) on July 1, 2011.
While the non-concessional contributions have limits, loans do not.
Both members of the couple could put in $2 million each, or $5 million each, and whittle it down by non-concessional contributions over time.
A straight loan (through a bare trust) of an unlimited amount of cash,or shares, could potentially be made into the super fund.
Are there any downsides?
Of course. Nothing that good could be without a hiccup.
The act of transferring parcels, inspecie, of shares into super will create a capital gains tax event in your personal name. You’ll need to weigh up whether paying some CGT now might be worth it to get the asset into a low, or no, tax environment. If your super fund is in pension phase, it may be the last time it ever pays tax on income or gains.
If you are making a loan by the traditional method of lending cash into the bare trust in the super fund, then, obviously, there are no CGT issues.
What’s the real point?
If you have $2 million in assets outside of super and then they double to $4 million and are sold, there is tax of potentially as much as (assuming they have been held for longer than a year) of $465,000 to be paid.
Make that same capital gain inside super and you’ll pay a maximum of $200,000 (10% of entire gain), or $0 if the fund is in pension phase.
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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 advised to consult your financial adviser.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.