SMSFs and borrowing – time to get worried?

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SMSF investors shouldn’t panic about stories on property spruikers and housing bubbles, but it would be foolish to completely ignore the warning signs.

Most trustees of SMSFs have the experience to avoid inappropriate, get-rich-quick offerings; it is perhaps less experienced people running smaller funds who might be at risk.

So, while most of the media talk has been inappropriately linking SMSFs’ ability to borrow to buy property with anticipation of a possible bubble in housing, the underlying concern is the relatively recent policy of allowing SMSFs to gear into property (and equities). Since borrowing was allowed, the growth in SMSFs has been rapid, shifting the balance of power in the superannuation industry.

The ability of SMSFs to borrow money to buy properties, which many have used to invest in their own business’s property, gives them an advantage over larger funds. This accounts for the recent comments by the new Assistant Treasurer, Senator Sinodinos, about the need for a level playing field across superannuation funds.

The Cooper Review

This, in turn, reflects inaction by the previous government, after the recommendations in mid-2010 from the Super System Review, chaired by Jeremy Cooper, that the government review the provisions allowing borrowing. On this timing, a review might have begun in 2012 and, by now, could have ventilated the topic. It might also have cooled the rise in borrowing, which attracted property spruikers trying to sell loans and property to wide-eyed SMSF trustees.

As for any action, both major parties have pledged not to make major or adverse changes to super in the next three years. If the Coalition maintains this stance – and the Prime Minister Tony Abbott has already re-committed to this statement – it’s difficult to see gearing by SMSFs becoming a factor for perhaps three years or more.

Nevertheless, for all but six of the 20 years of superannuation legislation, super funds couldn’t borrow. When the SIS Act set out the rules in 1993, it prohibited funds from borrowing. The September 2007 changes, which initially allowed SMSFs to gear, were introduced to help many investors who had borrowed to buy Telstra shares in the 2006 T3 issue of shares, when the Howard government successfully used the structure of instalment receipts to encourage investors to buy.

In its final 2010 Report, the Cooper committee argued the original policy of no borrowing was “…simply that leverage for asset acquisition amplifies both gains and losses and this was seen as placing members’ retirement savings at too much risk.”

The game at hand

Now, of course, a much larger and more sophisticated SMSF movement might claim that members are experienced and capable of assessing the risks of leverage for their own retirement savings. But prudential regulators, charged with ensuring the security of the trillions of dollars of savings, can’t ignore any risks to what is now a third of all super savings.

On the level playing field argument, cited by Senator Sinodinos, the big institutional super funds argue that they are disadvantaged by SMSF funds being able to borrow to finance the purchase of property associated with the funds’ members – in essence, getting the advantage of gearing within an already tax-advantaged structure, especially in pension mode.

In reality, the main problem has arisen because of the lack of control over dubious sales tactics, which can lead unwary investors into trouble with property investments when the temperature starts rising. This lack of control is a long-running story and goes beyond super funds. Despite the losses racked up in each property boom and bust, it seems no government is prepared to put controls on property sales similar to those on other investments marketed to the public.

While this debate may lie in the future, SMSF trustees should ensure that they stick strictly to the existing borrowing rules and other requirements for in-house assets. The recent statements by the various regulators are a signal that the authorities are aware of rising pressures, especially if interest rates start rising.

SMSF investors should also realise future events might cause a change in government policy – after all, superannuation now has a long history of legislative change – but the “no adverse change” policy should ensure that, as always, any change would not be retrospective.

Important: 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. Consider the appropriateness of the information in regards to your circumstances.

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