What is a SMSF LRBA?
Borrowing to invest can help build your investment portfolio faster with increased exposure to the market. Like any gearing, this can magnify gains or losses and therefore careful consideration should be given to whether its suitable for your fund.
A limited recourse borrowing arrangement (LRBA) involves a self-managed super fund (SMSF) trustee taking out a loan from a third-party lender. The trustee then uses those funds to purchase a single asset (or collection of identical assets that have the same market value) to be held in a separate ‘bare’ trust. Any investment returns earned from the asset go into the SMSF cash flow.
If the loan defaults, the lender's rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held in the SMSF, hence the name ‘limited recourse’.
How does it work?
You need to critically evaluate the appropriateness of any investments for your SMSF. Borrowing to invest requires some additional considerations:
- Does the Trust Deed of the fund allow borrowing to invest?
- Does the investment in mind meet the criteria to borrow to invest and be held in a bare trust arrangement?
- Will the cash flow of the fund support the repayment of the loan including a buffer for future interest rate increases? If not, will additional contributions be made to fund the repayments?
- Does the investment impede liquidity requirements for the payment of member benefits?
The order of transactions
There are a number of transactions that need to occur in a sequential order for the LRBA loan and asset within the bare trust to be valid. No deposits should be paid, or contracts signed, until the entire arrangement is agreed and validated.
Generally, the sequential order is as follows:
Step 1: Confirm the asset to be purchased
Step 2: Obtain pre-approval of the loan
Step 3: Identify trustee of bare trust to hold the asset
Step 4: Complete the documentation, as required, to enable the loan and trust transactions:
- The bare trust
- Company to act as trustee of the bare trust
- Updating the super fund trust deed
- Updating the fund’s investment strategy
Step 5: Sign the contract in the name of the bare trustee and pay the deposit from the SMSF
Step 6: Settle the property with the bare trustee as the title holder.
A common strategy for LRBAs is to borrow and purchased commercial property for your business and lease back to the business at commercial rates. This is allowed under SMSF law if the rental payments are at ‘market’ rates.
What should I be thinking about?
- Lenders are generally more conservative with risk in LRBAs as they have limited recourse to settle the loan if you default. They will require a larger deposit (30% or more) and will require strong cash flow from the fund to support the loan.
- LRBAs may result in a credit to a person’s transfer balance cap, reducing the amount that can be transferred to a tax-free pension in retirement. This only applies to funds that use the segregated assets method.
- The asset must be a "single acquirable asset" as defined in law. Professional advice to determine the suitability of the asset should be obtained where appropriate.
- Legal and tax advice should be sought for setting up the structures and trusts, and to confirm cashflow requirements of the loan.
- It takes time to set up an LRBA for the purchase of an investment. It cannot be rushed and the asset should not be purchased before the structure is put in place to complete the transaction.