What is an LRBA?
SMSFs can buy assets such as shares and property by using cash in the fund and borrowing the rest. A limited recourse loan is designed to enable you to borrow or gear your super into property and certain other assets, albeit with strict conditions and certain limitations. This can enable the SMSF to acquire assets it currently doesn’t have enough money to purchase outright. Provided the governing rules allow for it, SMSFs can borrow to invest by using what’s called a ‘limited recourse borrowing arrangement’ (LRBA).
Advantages of borrowing within your SMSF
- Potential for increased returns: Superannuation exists for the purpose of providing members with an income in retirement. Smart investment strategies in conjunction with a LRBA can improve your SMSF’s returns over time.
- Being able to transfer business premises into your SMSF: This is an attractive prospect for many small and medium-sized business owners. In cases like this, business owners take control of their Super, invest in their business premises and make the fund work smarter (not harder) for them. It’s a compelling proposition – a property earning market rate rent with potentially concessional tax benefits. But as always there are risks, so be sure to talk with us or a trusted accountant to discuss your personal circumstances.
- Diversification: A well-diversified portfolio can reduce risk and improve returns over time. Using a LRBA can assist in obtaining diversification in your SMSF.
- Tax advantages: Interest and other borrowing expenses are still generally tax deductible to your SMSF, which can reduce any tax payable within your fund.
The risk of borrowing within your SMSF
Like most things in life, there is risk attached to undertaking a LRBA. The main risk of borrowing within your SMSF is being unable to meet your SMSFs loan obligations. Overall reasons for not being able to make repayments can include:
- Change in personal circumstances: The death, disablement or divorce of a member can potentially require payment from the fund, which can result in your SMSF having to sell the asset or risk defaulting on repayments.
- Financial loss: The value of your investment can fall for a number of reasons, such as a general fall in market prices, or specifically a fall in the value of your SMSFs property.
- Regulatory risk: The rules that govern SMSFs and superannuation in general change regularly. These changes could impact what the SMSF can own, the circumstances in which it can borrow if applicable, the tax payable by your SMSF, and more.