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Borrowing within super

Q. Can I borrow to buy shares or property in my super fund?
 
A. The short answer to this question is yes, you can borrow to buy shares or property within superannuation. It most definitely can be done, but the real question is, should you borrow?

Let’s look at whether you should borrow within super first. Borrowing to invest is risky whether it involves property or shares, in or outside of super. Borrowing means that you have a larger investment and that you do not own a large portion of the investment yet. The main reason to own the larger investment is that as it rises in value, you make more money. However, the catch is if markets fall this also means you lose more money. Falling markets present even more problems: along with the fall in capital values, you may suffer a reduction in income while your fees and interest stay about the same. In this situation, you will come under a lot of pressure (or your super fund will) and if you have to sell, you will lose your initial investment and be worse off than if you had never borrowed in the first place. You may also have to contribute more funds to super to meet any shortfalls.

I will let you in on the only secret to successfully borrowing to invest. The secret is not the tax advantages (despite what your accountant tells you), but it is to ensure the asset you buy will grow in value. This sounds simple, but let’s look at home owners in the US. A lot of them borrowed to buy properties they could not afford based on the assumption that property prices ALWAYS went up. How wrong they were. So, if the asset does not go up consistently each year then the interest and extra fees and charges eat into your returns and reduce the effectiveness of this strategy. This is why the government regulates super and regulates borrowing within super. Believe it or not, this regulation is trying to protect investors from themselves, as the government and, ultimately, you, want the funds to be there when you go to retire.

So, I would suggest that, at the very least, before looking to borrow within super you examine the fees and charges (note that larger investments often mean larger fees if the fees are percentages), stress test your situation looking at a number of different scenarios (using different returns and interest rates) and, most importantly, do some financial projections to see if you really need to borrow to meet your retirement goals or if this is an unnecessary risk. If you feel this preparation and research is a bit beyond you, I would recommend you see a Switzer financial adviser for help.

So now I have got that off my chest, let’s answer the first part of the question: borrowing within super can be simple or complicated. So, let’s start with simple.

You can purchase a managed fund that buys and sells shares, domestic and/or international (including listed property) and that can borrow within the fund for you. There are a number of managed funds that have been around for a while displaying a track record of how successful they are at investing clients’ funds in this manner. These funds borrow by either having a loan facility in place or by placing a bet that an asset will go up or down and then only investing a small down payment to gain exposure to bigger investment movements. Before buying into such a fund, you should refer to the fund’s investment rules to see what they invest in and how they borrow, what limits they place on their borrowing and investing practices, and it would also be a good idea to review the fees and charges of the fund. Note that some of these managed funds are referred to as hedge funds, so are more risky than other managed funds.

The other alternative is to borrow to buy shares or property directly. But this is not as easy as it sounds. Superannuation is highly regulated and you will need to ensure the borrowing and the assets you intend to buy are allowed in your fund, whether it be a Self Managed Super Fund or a Master Trust Super Fund (SMSF) offer to you by your financial adviser. With a SMSF, as you are the trustee, it is your responsibility to know what can and cannot be done.

The super rules allow you to borrow so long as the loan is only secured by the asset used to purchase the loan. The loan cannot be secured by you personally or by other assets. This means that this type of borrowing is more complicated than your usual borrowing arrangements.

As a result, to buy shares or property directly, you need to buy the asset and the loan all packaged up. When buying anything as a package, you need to do your research to carefully determine what you are getting yourself into, after all this is your retirement you are playing with, and could spell the difference between continuing to work to age 70 verses going overseas each year and not working from age 55 or 60.

To buy direct shares using borrowings, you can buy a prepackaged loan and share investment from the large institutions (or banks). Typically, you invest half your money and borrow the other half. The range of shares you can buy is limited and is usually restricted to the top 50 shares.

This type of product then uses the dividends to help pay off the loan over the life of the investment. You do not have to pay anything further. Note that interest accrues against the loan over the life of the investment. The complete structure of this type of investment was in the past quite complicated – they are referred to as self funding installment warrants, so even the name is complicated. Having recognised this the people who come up with these offers have now started to simplify them for investors.

At the end of the investment term, you can sell the investment, or pay off the loan and keep the shares or let the investment lapse if it is no longer worth anything.

I would suggest that if you want to go down this path you educate yourself about warrants and you may want to start with a course at the Australian Securities Exchange (ASX). The alternative would be to see a financial adviser who can help you, such as Switzer Financial Services - click here to book a complimentary first appointment.

If you wish to buy property, the rules are the same as mentioned above for share purchases, except you buy a property. As you would most likely be doing this within your SMSF, you have more choice about which property investment you want to borrow to purchase and your borrowing levels. A word of caution: with a property, the investment would usually be a lot larger than if you were buying shares. Also, shares trade on a listed exchange each day and the product issuer is forced by the ASX to buy your shares (warrants) back off you if you want to sell (but potentially not at the price you want). Properties do not have a market that tells you their value every day and there is no one that is required to buy the property back off you if you get into trouble. Most importantly, if you need money urgently, you need to realise you may have to wait up to three months for settlement before you can get your hands on the funds.

Overall, borrowing in super is possible, but due to the tricks and traps involved I would suggest you seek professional advice before proceeding down this path. I would also suggest you obtain advice from a person other than the party offering you the loan and investment package to ensure you obtain independent advice suitable to your needs.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

 

 

Published on: Saturday, July 18, 2009

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