Self managed super funds (SMSFs) can be complex beasts. They allow a person to manage their own superannuation, investing it in their preferred assets using their preferred method. But what if that preferred method is lending money, perhaps to a party related to an SMSF member?
Maybe you’re looking at the balance of your SMSF wondering if there’s a better use for those funds outside of investing in various asset classes?
For the most part, a person can’t access their super until they reach preservation age. But there is a way you can lend out some of the money kept in your SMSF. Though, any SMSF trustee contemplating doing so should be aware of the many limitations and restrictions involved, particularly when it comes to lending to related parties.
Can SMSFs lend money?
Banks and lenders make the most of their coins by handing out cash to those who need it. They typically profit (or at least aim to profit) off the interest that borrowers pay on top of their principal repayments. But it’s not just lenders that can make the most of people’s desire for funds. An SMSF can also lend money under strict conditions.
For starters, lending money has to be included in an SMSF’s investment strategy and trust deed. If it’s not, you’ll probably need to update both documents before loaning money.
A loan must comply with an SMSF’s ‘sole purpose test’
As mentioned above, the golden rule to operating an SMSF is that the fund must aim to provide retirement benefits to its members. That’s no different when a fund is lending money. An SMSF trustee must expect the fund to earn a return from the loan.
Thus, it must receive interest that is at or above going rates on the market. It will also need to have defined terms, like a set repayment period and schedule. If it doesn’t meet the above criteria, the SMSF could be deemed non-complying and therefore find itself ineligible for concessional tax rates.
Assessable income of an SMSF is normally taxed at a rate of 15%. However, if the fund is non-complying it’s taxed at 45%. Ouch.
An SMSF cannot lend to members or their relatives
The other major restriction an SMSF must adhere to when lending money is that it cannot lend to a member or a member’s relative.
That means you can’t borrow from your own SMSF to buy a new car, for instance, even if you’re paying back the cash plus interest. Nor can your SMSF lend money to your kids to help them buy their first home, even if doing so would be a good investment decision.
In addition to that, a person can’t use funds from their SMSF to provide any sort of financial assistance to themselves, a fellow member, or their relatives.
The ATO will likely fine anyone it finds to have breached these rules come audit time.
Loans from SMSFs must be ‘at arm’s length'
However, and perhaps confusingly, an SMSF can lend money to ‘related parties’ – an entity (say, a small business for instance) closely linked to a member or a member’s relatives – as long as the loan is expected to make the fund money.
Under such circumstances, the loan needs to demand a commercial rate of interest and must not be used in any personal capacity – it has to be managed at an ‘arm’s length’ basis. That’s particularly important as, as previously mentioned, any income realised by an SMSF that’s deemed to be ‘non-arm’s length income’ will be taxed at the highest marginal tax rate – 45%.
But wait, there’s more... catches that is. A loan to a related party will count as an in-house asset. Only 5% of an SMSF’s assets can be in-house assets at any given time. Thus, a $30,000 loan can only be given to a related party if an SMSF has $600,000 of non-in-house assets as well (5% of $600,000 is $30,000).
Anyone considering loaning money from an SMSF to a member, a friend, or a family member should take care in doing so. They might even find value in reaching out for independent advice on the matter.
Security on a loan from an SMSF
There are plenty of situations in which a bank or lender would ask that a borrower provide security (or collateral) for a loan. Any loans offered by an SMSF needn’t be different in that respect.
So, what could security be? Security is typically another asset that’s owned by the borrower – perhaps a car, jewellery, or gold. A borrower might promise to hand the asset over to the lender if they fail to meet their repayments, thereby sort of ‘insuring’ the lender against losses. That way, if a borrower were to default on their loan, the lender isn’t left with nothing.
If a bank or commercial lender would ask that a loan is secured, it’s probably a good idea for an SMSF to ask the same. Indeed, it’s feasible that would need to be the case to achieve commercial terms and keep the loan ‘at arm’s length’.
Can SMSFs borrow money?
Of course, as most people managing their own superannuation will know, SMSFs can borrow money to buy assets, such as property. Though, the loans available look notably different to typical home loans. There are two avenues in which SMSFs can borrow money:
1. Related party loans
A member of a SMSF can loan to their own fund, if they wish to. They might even take out a loan themselves and simply hand the borrowed money over to their SMSF. However, any such loan must still be made at arm’s length.
To guarantee a loan passes the ‘arm’s length' test, a fund needs to pay a set rate of interest to a lender. Such set rates are called ‘safe harbour' rates and are decided by the ATO. They may also be higher than one might expect.
For 2023-2024, SMSFs borrowing through a related party loan for the purchase of real property must pay an 8.85% p.a. interest rate in order for the loan to definitely be considered at arm’s length. That’s bumped up to 10.85% p.a. for loans funding the purchase of listed shares or units.
2. LRBAs
Loans provided to SMSFs are what’s called limited-recourse borrowing arrangements (LRBAs). In the case that a SMSF defaults on its loan, its lender can only take back the asset the loan was used to buy as security, thereby protecting the rest of the superannuation fund. The end result is that interest rates are usually higher.
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.99% p.a. | 7.00% p.a. | $3,323 | Principal & Interest | Variable | $null | $720 | 70% |
| Promoted | Disclosure | ||||||||||
7.24% p.a. | 7.26% p.a. | $3,407 | Principal & Interest | Variable | $0 | $710 | 70% | Disclosure | ||||||||||||
7.75% p.a. | 8.13% p.a. | $3,582 | Principal & Interest | Variable | $0 | $445 | 60% | |||||||||||||
7.49% p.a. | 7.50% p.a. | $3,493 | Principal & Interest | Variable | $0 | $720 | 80% |
| Promoted | Disclosure |
Image by Medienstürmer on Unsplash.
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