A Super Investment for your superannuation

A Super Investment literally!

Australians love property. In fact, 1 in 5 households own an investment property but less than 4% have used their super to make it a Super Investment. The reasons are that super funds are not allowed to borrow, and, SMSFs with smaller balances can't afford a large lump sum investment like property.

A change in legislation in September 2007 has opened up a window of opportunity that provides access to borrowed funds under certain circumstances. In effect, you can then borrow money for purchasing an investment by instalments. Naturally, the investment must still be an asset that the super fund is allowed to invest in. The structure that makes this possible is commonly referred to as an instalment warrant. It is based on an exception to the borrowing prohibition of super funds.

Instalment warrants can be used for property but also work with shares or managed funds. Trustees have used instalment warrants on shares for many years even though there was no clear explanation in the legislation that officially allowed them to do so. It was considered borderline then but is fully accepted now, e.g. the Telstra share offer a few years back was a similar arrangement where trustees paid for Telstra shares in instalments.

What makes property a Super Investment?

First, let's recall some of the advantages of investing in property as such:

• visible bricks & mortar is always welcome with the banks,
• a tenant paying good market rent,
• tax-effectiveness from depreciation allowances,
• population growth driving capital gain; and more.

Property investors have all experienced the investment power from property through its continuity to perform in good and bad markets over a long period of time. Now, add to this a tax friendly environment such as in superannuation and you will get one of the best performing investment vehicles available in Australia, i.e. a Super Investment.

How to structure your Super Investment

Direct property bought through superannuation almost always requires a Self Managed Superannuation Fund (SMSF). The majority of SMSFs have an asset size of $200,000 to $500,000 worth of assets (Source: ATO, Self-managed super fund statistical report, March 2010). This means that they often fall short of cash to fund a property purchase outright.

That's where instalment warrants come in. They work a treat with property and are nothing else than a possible structure to allow a SMSF to access borrowed money although it is prohibited from borrowing.

In the following, we'll call this structure for our Super Investment aproperty warrant

How do property warrants work?

As a start, it is necessary to have a complying SMSF, of course. In addition, a separate entity is required to hold the investment property on trust for the self managed super fund. We call this trust the property trust or security trust (when used for securities instead of property).

• The property trust will be the legal owner of this Super Investment and hold the investment property on trust until it's fully paid for by the SMSF.
• The SMSF is the beneficial owner of the property and can receive the investment property from the property trust after the final payment is made.

Next, we need to identify an investment property meeting the usual lender's eligibility criteria such as type of property, location, market value etc.

Let's make an example:

Jim and Katie are members and trustees of their self managed Smith Family Superannuation Fund. They earn $80,000 each and have a combined super balance of $150,000. They consider purchasing an investment property for $400,000. The SMSF makes an initial deposit of $100,000 for their Super Investment and the trustees apply for a superannuation loan to borrow the balance of $300,000 from a compliant lender.

The following schematic shows a property warrant structure applied to the property that Jim and Katie want to buy. It is also showing the rent flowing as income from the property back through the Property Trust into their SMSF.

In addition to the rent, Jim and Katie will receive a minimum of 9% of their salaries paid as employer super contributions into their SMSF. This is worth $14,400 per year which will assist them in fast paying down the SMSF Loan.

How To Use Super As A Deposit To Buy Property?

Been there, done that! ... or are you thinking about it? Tell us your experience with using a self managed super fund for investing in property.

Do you think instalment warrants work well? What makes such an investment structure worthwile?

Read other Super and Property Reviews

Click on the links below to see some great reviews about using a SMSF to invest in property.

Making the structure work

Initially, the Smith family super fund pays the first instalment for their Super Investment. This is the initial deposit of $100,000 which equals to 25% of the property purchase price. The required deposit amount will vary depending on the chosen lender's gearing policy. They also pay the purchasing costs of, say, about 5% of the purchase price or $20,000 for loan costs, legal fees and stamp duty. This leaves them with $30,000 of cash reserves in their fund.

Note that it does not make sense to heavily gear in a super fund because a SMSF gets many tax benefits already anyway when compared to non-super gearing.

Once a super loan is set up, the cash flow of the super fund must be able to pay the interest on the loan, periodic loan repayments and associated costs with the super investment property such as maintenance, repairs, council rates, etc.

Repayments are seen as instalments which can vary in size and frequency. Each time the Smith family super fund receives additional funds from contributions and rent it makes another instalment payment until the loan is fully paid down. During that time the property will be held on trust until the final instalment is paid or the property is sold. The SMSF receives all the capital growth along the way too.

What are the rewards?

Although the Smith family super fund requires an instalment warrant for investing in a property, it looks fairly similar to other property investment arrangements. However, the big benefits that make this literally a Super Investment result from using self managed super instead of any other ownership structure.

These benefits are:

• Wealth Creation through gearing – Borrowing to invest allows your SMSF to accumulate superannuation assets faster and provide more assets and income for retirement. It gives you the opportunity to increase your wealth and returns in a way that without borrowing would not have been achievable.
  
  
• Affordability - A benefit of borrowing in super is that potentially you can afford to borrow more or to make instalment payments faster as you are teamed up with other members. The servicing on the loan can be funded not only from the tenant's rental payments but also from employer’s compulsory 9% super contributions, salary sacrifice contributions, personal and spouse contributions, pooled contributions from all the members and the Government co-contribution.
  
  
• Simplicity - Super is now simpler and more flexible because there are no restrictions on how much you can withdraw in retirement and no requirement to withdraw any funds ever.
  
  
• Time To Succeed – Super investments are locked away until you retire and you are free to keep them for longer. This buys you time to make your investment a success.
  
  
• Reduced Risks - A key feature of property warrants is that the borrowed funds are advanced on a limited recourse basis, meaning the only amount you stand to lose is your original deposit you paid out of your super fund and down payments on the loan protecting your other assets from creditors including any other investments you may have in your SMSF portfolio.
  
  
• Efficiency - There is a maximum of 10% capital gains tax on the sale of the investment property if held for at least 12 months and potentially nil if sold in pension phase (retirement). There is a maximum of 15% tax on rental income and potentially nil in pension phase. The interest cost of the instalment warrant, other loan costs, property expenses, property depreciation are potentially tax deductible and can reduce the effective tax rate of the SMSF to nil.
  
  

What are the results?

We have calculated the financial outcomes for the investment property of the Smith family super fund assuming 3% inflation, 4% capital growth, $390 rent per week with a vacancy rate of 2%, $7,200 or 9% employer super contributions for each member, principal and interest payments on the loan over 25 years at 7%.

There are more parameters we could throw in but this gives us a good indication already of what we can achieve. Now, we also assume that the property will be sold after 10 years and compare this to a non-super investment.

The end result is nothing short of magic:

Jim and Katie are a total of about $132,000 better off by buying the investment property in the Smith family super fund rather than in personal names.

This figure results from about $25,000 less capital gains tax in super (if sold after 10 years), fast down payments on the superannuation loan creating a savings of about $38,000 due to positive cash flow and, if held outside super, the negative gearing holding costs of about $69,000.

This means that there will be $132,000 more available for retirement generated from exactly the same property held for the same number of days with same outgoings, costs and exposure to risks as if held in personal names. Not to mention that you'll also be able to save about $15,500 of capital gains tax if the property wasn't sold but held until pension phase in retirement instead.

Who wouldn't you want to achieve that?

This is only one of the magic SMSF super investment strategies that we can use to improve our personal finances. Needless to say that this is not possible with 'normal' superannuation funds such as retail funds or industry funds.

Check out our eReport below or make an enquiry about high performance properties currently available.

More information:

Superannuation Australia
Superannuation Funds
SMSF
Self Managed Super Funds
Self Managed Super - What does it cost?
Super Investment
Super Secret
Lost Super
Annuity
Centrelink Australia
Retirement Calculator

Return to Rewarding Retirement Advice
Return to Discover Financial Freedom

www.Discover-Financial-Freedom.com
c/o Equity Resource Pty Ltd, PO Box 8056, Baulkham Hills NSW 2153
phone 02 8861 1688

Write your New! Comment about this page.