There is no doubt that property investments are a hot topic right now. So many people feel that they are missing out, and are looking at ways they can increase their exposure to property.
Residential Property investments have always been a key platform and asset class for Aussies as they consider retirement. With the advent of SMSF, it is only natural that the concept of retirement and residential property would come together.
The Property Market
When people consider investing in residential property, it is well understood that an SMSF cannot purchase a residential property from a member of or associate of a member of the fund. However, there is no specific rule that prohibits an SMSF from SELLING a residential property to a member of the fund.
The trustees of an SMSF must always ensure that the decisions they make are designed to maximize the benefits to members, with those benefits crystalizing in retirement. The trustees of an SMSF must ensure that all transaction are undertaken on an arms-length basis. From a practical point of view, this means if a property is sold from an SMSF to a member it must be done with due consideration of the market conditions in existence at the time of sale.
An SMSF is a vehicle that gives members control over how their retirement funds are invested. Trustees often invest in :
- Listed shares
- Real Estate
- Term deposits/cash
Providing that you follow the guidelines, it is possible for an SMSF to borrow funds to acquire property within an SMSF, and in turn, complement the retirement strategies of the member/s.
As a general concept, many people like to approach retirement with Nil or Minimal debt. Why?
Once the debt has been repaid this often gives retirees more choices and less stress to plan out their retirement years, knowing that their actions are not accountable to any bank manager and/or credit provider.
Traditionally, if you borrow to purchase a residential property, which is held as an investment, you obtain a tax deduction for the interest you pay on the loan, but you don’t get a tax deduction of the principal reduction you make to the loan.
Remember that if entering retirement debt-free is a key strategy, then significant after-tax dollars will need to be diverted from living costs to debt reduction.
To illustrate the point, let’s wrap some numbers around a possible plan of action.
If you have high-income levels, and you are in the 47% marginal tax bracket (45% tax plus 2% Medicare levy) then any income you receive you can do 3 things with it :
- Spend it on lifestyle costs
- Save and Invest it
- Prioritise the reduction of debt
All 3 options are using after-tax dollars.
As a general concept to illustrate a point, each $1 of gross income is reduced by 47 cents dollar for tax and levies leaving 53 cents behind for you to allocate as above, but with a focus on debt reduction.
However, let’s assume you have borrowed funds to purchase a property in your SMSF. The rent and investment income the fund received can be used to repay the debt. But did you know contributions received by the fund can also be used to reduce debt?
So if you take your $1 of gross income and place it before tax as a concessional contribution to your SMSF you can use that to reduce personal tax payments.
Now here is the interesting thing, that $1 contributed to super (provided is within specific limits) and claimed as a tax deduction means you do not lose 47 cents in the dollar of it.
Once the $1 hits the superannuation fund, you lose 15 cents as a contribution tax, but that still leaves 85 cents available to reduce debt.
Remember in the example above you had 53 cents available to reduce debt, now you have 85 cents.
The potential tax saving of 32 cents means you can extinguish the debt more quickly and enhance your retirement plans.
Over a 10 to 15-year time frame, the savings can be significant.
Furthermore, once you retire, if it suits your retirement plans, the property owned by the SMSF can be sold to a member. For example, you may have purchased a property in Cairns in an SMSF, rented it out to others over many years, and then should you wish to live out your retirement years in Cairns, the fund could sell the property to you.
Sure at that point in time there will be retirement, stamp duty and taxation issues to understand and consider, but in the interim, you have gained exposure to the Residential property asset class, in a tax-effective way.
From the 1st July 2021, the level of concessional contributions per member that can be paid into superannuation will increase from $25,000 to $27,500. So for a husband and wife couple that potentially means an extra $5000 in pre-tax dollars can be channelled to debt reduction.
Currently, a significant number of SMSF clients may have equity investments that have performed extremely well or cash holdings that are generating minimal returns. Those current assets can be rebalanced to property and used to fund a deposit to complement property investments.
This simple example illustrates the importance of understanding how the taxation rules associated with an SMSF can have an impact on your retirement planning.
Many trustees know what an SMSF is, but need help in driving the vehicle to maximize its benefits.
If you are unhappy with your current SMSF service provider, or if you know of anybody who might benefit from our services, please contact David Darrant on 07 5437 9900 or firstname.lastname@example.org. We value our ability to create professional pathways for young locals in the SMSF environment, and every 20 SMSFs that we process allows us to give another young local an employment opportunity. We greatly appreciate your continued support and referrals.
The comments made above should not be view as specific advice, A person should not act on the basis of this information as it has been generalized for educational purposes. In particular, the information does not consider all of the matters that might be relevant to a particular client in particular circumstances. As these notes may apply differently to different people in different circumstances, the notes should not be used as a substitute for specific tailored expert advice.
If you seek specific advice please let us know and we can refer you to obtain expert advice.