The primary reason for the general restriction on borrowing by an SMSF is to reduce the risk to retirement income from funds gearing their assets.
However, there is an exception that does allow an SMSF to borrow if the strict rules outlined in the Limited Recourse Borrowing Arrangements (LRBA) laws (s67A of the SIS Act) are followed.
How do they work?
Generally, when an entity or individual borrows money to purchase an asset, the lender may have recourse to other assets of the borrower to ensure the loan can be paid in the event of a repayment default.
Borrowing within the LRBA rules requires the SMSF trustee(s) to setup a side trust (known as a ‘bare trust’), that purchases the asset on behalf of the fund. Therefore, the bare trust owns the asset on behalf of the superannuation fund.
Accordingly, this structure allows the SMSF to continue to meet the SMSF borrowing rules as recourse by the lender for repayment default is limited to the asset purchased by the bare trust. The remaining assets owned by the fund are protected against any claims by the lender.
Using an LRBA
Once the LRBA is setup, borrowings are used to purchase what is known as a single acquirable asset. This could be, for example, a parcel of shares all held in one company, or property that is held under a single property title (or possibly multiple titles if the property is distinctly identifiable as a single asset).
SMSF trustees looking to gain diversification and long-term capital growth of the fund’s assets in line with their investment strategy sometimes look to an LRBA to gain access to the property market. This has been of more interest in recent times where contribution limits have been lower than in the past, potentially limiting member balances and the ability to gain exposure through an outright purchase.
Lenders for an LRBA will have strict lending requirements, which may include having a consistent flow of member contributions if the property income is insufficient to meet lending criteria. Once lending is approved, the steady stream of member contributions and income from the asset acquired provides the SMSF an inherent way to make loan repayments.
Risks and limitations for an LRBA
LRBAs are a specialised area and not suitable for every fund. SMSF trustees should firstly obtain financial advice to ensure it suits the member objectives of the fund, and will meet the lender’s requirements.
The legislation and technicalities with an LRBA are also complex. Challenges can arise in respect to:
- Ensuring the fund’s trust deed allows for LRBA borrowing
- Definition of a ‘single acquirable asset’
- Understanding the impacts the lending has on superannuation thresholds and member balances
- Investments in property when parsing the differences between making repairs, making an improvement, and ensuring there is no change to the ‘character of the asset’.
We’re here to help
At Grant Thornton, we offer a National Superannuation team to support you and your family with the accumulation phase of your superannuation journey, right through to retirement.
For further details, or advice and guidance on limited recourse borrowing arrangements in an SMSF, please reach out to your local adviser today.
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The above information is provided as an information service only and, therefore, does not constitute financial product advice and should not be relied upon as financial product advice. None of the information provided takes into account your personal objectives, financial situation or needs. You must determine whether the information is appropriate in terms of your particular circumstances. For financial product advice that takes account of your particular objectives, financial situation or needs, you should consider seeking financial advice from an Australian Financial Services licensee before making a financial decision in relation to any of the matters discussed.
