Who will pay for your retirement?

With an aging population and ever-decreasing government resources, Australians are looking at being less reliant on the social security safety net and planning personal strategies to give themselves comfortable financial security in later years.

Given the vagaries of the stock market, investing in property is being recognised as a less risky way of owning a tangible investment that accrues in value over the long term.

As with any investment, the question is, which structure do you use to accumulate and manage your wealth?

Independence starts with an SMSF

Investing in specific property using superannuation requires you to have control of your funds via a self-managed superannuation fund (SMSF) and not a retail or industry fund.

There are some basic requirements in setting up an SMSF such as having a maximum of four members who are individual trustees or directors of a nominated company.

Compliance with the Superannuation Industry (Supervision) Act (SIS Act) and appropriate taxation law is also critical.

Establishing and managing a compliant SMSF may appear daunting but this isn’t the case if you follow some basic rules.

Importantly a property purchased using debt can’t be held within the SMSF but outside in a holding trust whereby the SMSF still has full benefits notwithstanding this additional structure.

There are also some regular costs associated with having an SMSF, so these need to be weighed up against the benefits and viewed as part of the overall investment.

Taxation

For some people, marginal tax can be as high as 49 per cent.

Conversely, the tax on superannuation earnings is only 15 per cent, while on capital gains it’s 10 per cent when in accumulation, dropping to zero when in pension stage.

There are allowable caps for each and each type is an aggregation of monies from any source.

The current superannuation guarantee requirement to put 9.5 per cent of your wages into super (increasing to 12 per cent by June 2021) forms part of your concessional caps and is a healthy kick-start to investing in your future.

With an SMSF each member is entitled to contribute additional concessional contributions up to an annual $30,000 cap for the 2014-15 financial year and beyond, or $35,000 for individuals who are 49 years old or older as of June 30, 2014.

These concessional contributions are taxed at the lower superannuation rates rather than your marginal tax rate.

You can of course contribute non-concessional after-tax funds of $180,000 per annum, or even bring forward up to $540,000, being three years of contributions into one year per member.

There are therefore no tax disadvantages to owning the property inside super versus outside super while working and in accumulation mode.

Property smorgasbord

With an SMSF you can purchase any type of property including new or existing, cosmetic renovation, residential or commercial, land (not for development), and even off the plan.

You can also purchase your own business property and lease it to your company on commercial terms.

There are, however, two principal restrictions: you can’t purchase a residential property of another member; and, the property you purchase can’t be changed to such an extent that it’s no longer the same asset as what you originally purchased if using debt.

While improvements are allowable, even if the property has debt, the improvement must be paid for using SMSF cash resources and not additional borrowings. Improvements can

include items such as additional rooms, a granny flat, or a deck.

However, if these are contemplated then a more appropriate finance structure may be required if there are limited funds in the SMSF.

The cosmetic renovation is actually deemed to be repaired for the purposes of the SIS Act, although for tax they’re not expensed but depreciated as normal.

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Existing commercial property

While you’re restricted from purchasing residential property from a member or related party, you can buy a commercial property of one of these sources.

There may be an advantage to sell an existing commercial property into your SMSF and use any additional borrowings from the existing amount to retire non-deductible debt as the super fund will get a tax deduction for the entire loan required to purchase.

If ownership is currently by an individual then most states have a $50 or $500 stamp duty.

Capital gains tax would be payable on the sale, but this could be reduced by the 50 per cent general discount, 50 per cent small business concessions, retirement super contribution, and concessional contributions.

Financing

An SMSF can borrow funds from anywhere including banks and members so long as any loans are formalised and at commercial terms and conditions.

All loans must be under a limited recourse borrowing arrangement, so loans to an SMSF tend to be slightly more expensive notwithstanding banks require in many instances further guarantees external to the SMSF.

In the scheme of things, the tax benefits would normally far outweigh these additional costs.

Loan-to-valuation ratios (LVR) are not normally over 80 per cent.

This means the SMSF must have the deposit (20 per cent at least) plus costs (stamp duty, legal fees, borrowing expenses, and so on) as internal funds.

However, the SMSF can borrow to pay for all other property costs including purchase and costs for repairs and maintenance.

The total value of initial borrowings from all sources can later be refinanced from any other lender but to no more than what was initially borrowed.

This means that the SMSF can’t refinance to use equity for additional purchases.

Asset protection

Specific legislation protects your super fund balances, even in bankruptcy, as long as the contributions were in the normal course.

As the sole purpose of super is to provide retirement income there’s a slight issue when in retirement as pension payments are now outside super and these can be attacked by a receiver in the event of bankruptcy.

The use of a corporate trustee, as opposed to individuals, can help in this instance.

Estate planning

With four members in an SMSF, it’s easy to join forces to build a deposit.

While it’s true that blood is thicker than water, working with family and friends can be challenging.

Within an SMSF it will be more difficult to split than if the investment were made outside super but this isn’t insurmountable with due diligence and an effective exit and estate planning strategy.

Having appropriate insurance is also critical.

Summary

Purchasing property directly through an SMSF as part of a long-term, independently funded retirement strategy can be a financially rewarding exercise for many people.

The downside includes some restrictions on improvements and changes to the property and the inability to refinance for further purchases.

On the plus side, the tax benefits can be significant and if you’re unable to personally purchase at present outside of super then your superannuation guarantee contributions and super balances may assist you in purchasing within your SMSF.

An SMSF also has its own land tax threshold, irrespective of what other properties the members may have, which is an additional benefit.