Purchasing Investment character in Your Own Name – Have You Thought About Using Your Superannuation?
Using negatively geared character has been a favourite of Australians to build wealth for a long time – and it is easy to see why with proven capital growth, the easy ability to borrow to fund character purchases and a nice big tax refund at the end of the year.
But is this strategy nevertheless the best option now that SMSFs can borrow to acquire both residential and commercial character? This article will compare each strategy and provide some insight to permit you to make a better informed decision about your next (or your first) investment character buy.
First Match – Financing:
To finance the buy of your investment character, you are going to need to borrow. This method paying a visit to our friends the edges. In Australia the home lending market is dominated by the big players – and in regards to the loans obtainable to SMSFs it is no different. Leading the pack are Westpac, NAB and St George. CBA also have a lending product – however it is more restrictive than the others.
The LVRs obtainable when obtaining an SMSF loan compared to a normal investment character loan are slightly reduced – typically being 72% – 75% for residential character and 65% for commercial character. This will average you will typically need a larger place if buying via an SMSF – however for the majority of people this is not going to be a problem as likely you will have more obtainable in your super than sitting in your savings account.
In addition to the lower LVRs, the formation and legal fees charged by the edges are considerably higher for a SMSF loan when compared to a typical investment character loan. Once again these additional costs can be offset by the additional superannuation monies you have obtainable – i.e. you don’t have to fund it out of your own pocket.
When it comes to the lending side – borrowing via a SMSF is always going more expensive than a typical investment character loan both in terms of the set up.
Negative Gearing: 1 SMSF: Nil
There is a compromise here though. If you personally have enough equity obtainable in other similarities to fund some or all of the borrowings the SMSF requires to complete the buy of a character you can become the bank and lend to the SMSF. This is referred to ‘member financing’ and can be used as a substitute or complimentary to bank financing. This method significantly reduces the borrowing costs.
Second Match – Taxation:
You are probably wondering what the taxation consequences are when comparing negative gearing against the SMSF purchasing a similar character? It works like this: A character is negatively geared when the total taxable income generated from the character is less than the total deductible expenses relating to it.
For example if your negatively geared character was costing you an additional $200 per week, over the period one financial year your overall tax deduction (negative rental income) would be around $10,000. If you marginal income tax rate is 30% + 1.5% Medicare you would expect a refund of around $3,150 at the end of the year. Overall you are nevertheless out of pocket by around $7,000.
If a character with the same costs was held by your SMSF, you can salary sacrifice $200 of pre-tax income to cover the loan repayments and other character related expenses. You do not pay income tax on any amount you salary sacrifice, so if that amount totals $10,000 per year – then just like the above example your tax saving is the same – but instead of paying the ATO week to week and then getting a refund at the end of the year, you are simply not paying tax on that money at all.
Now, as you may know any employer ‘concessional contributions’ such as salary sacrifice into super are taxable by the super fund at 15%. However, the SMSF is also entitled to the same deductions relating to the character that you are – meaning there will be a nil tax impact.
So, when you compare the strategies, the week to week tax impact is the same. However, when it becomes time to sell the character and realise the capital gain the SMSF is the clear winner. If the character is held for more than twelve months, the SMSF pays 10% on the capital gain – so if the character was sold for $150k more than you paid, the SMSF would pay $15k in capital gains tax. By comparison if you held the character in your personal name and you have wages income of $80k, the tax and Medicare payable would be just under $30k.
But wait – there’s more! If you keep up the character long term in your SMSF and commence a pension when you reach age 55, all the income (such as rent) and capital gains on assets used to sustain that pension (such as the character) are tax exempt. If $15k tax is better than $30k tax, then $0 tax is the Holy Grail.
Negative Gearing: 1 SMSF: 1
Third Match – Access to Funds:
Another important consideration is access to funds. Monies contributed to super must stay in super until at the minimum age 55. By comparison if you profit from the sale of an investment character held in your own name the proceeds can be used to pay off your mortgage, credit cards, car loans, pay for a holiday or buy a boat.
However, if you goal is to continuously build up a character portfolio to provide income for your retirement and you intend to re-invest any gains you make into more similarities, the fact that you can’t access the funds becomes less applicable.
As I mentioned, super monies must stay in super until age 55. If you are like me that time is a long way off – but what about your parents? Chances are they are a lot closer or more likely over that magical age already.
There is a way for your parents to help you buy your first investment character, while simultaneously generating a healthy return on their money AND providing the method for you to legitimately unlock some of the equity you will build up in your SMSF investment character. To find out more about this fantastic strategy you need to read my other articles and also check out my blog via the link at the bottom of this article.
Negative Gearing: 2 SMSF: 2
Fourth Match – place:
As before mentioned like most average Australians you probably have more obtainable in your superannuation than you do in your personal savings account.
Utilising a SMSF to access this money as the place for an investment character method two things:
- You can buy your investment character sooner
- With the higher place you are more likely to be able to buy a character that is cash flow positive
Saving money for investment purposes is hard, it takes a long time, the earnings on those savings are typically low and you get taxed on that interest to boot! Utilising your super method you can get into the market sooner and start to build your wealth sooner.
So you are probably wondering how much is enough to get started? Well – it depends! Refer to my other article “Self Managed Superannuation Fund (SMSFs) – How Much is Required to Set a SMSF Up?” for more information about how much is enough.
The ideal situation in my opinion with any character investment is to find a character you can provide that has positive cash flow. This method the monthly income from the character is more than the monthly expenses. A good way to think about it is like this:
Q: If a character costs you $100 a month, how many can you provide to own?
A: Maybe two or three before it costs you too much
Q: If a character gives you $100 a month, how many can you provide to own?
A: As many as you can save a place for!
If you have read anything from Robert Kiyosaki of high Dad / Poor Dad fame you will know exactly what I am talking about.
As before mentioned, when borrowing by a SMSF the edges require a larger place (i.e the LVRs are lower). The silver lining with this is that with the higher place, the more likely you will be able to find a cash flow positive character.
Add the taxation impacts of depreciation and capital works allowances obtainable via a quantity surveyors report and you may already be positive cash flow but negative rental income for tax purposes!
So what if you do the sums and you calculate that you are well short of what you need to buy a cash flow positive investment character? If you find yourself in this position I suggest you do the following:
- Have you included the current super of you and your husband / wife / defacto? Combining both your current super balances into an SMSF may give you that larger place.
- Are your parents willing to help you out? If they tip in an additional $20k will this get you over the line?
- Can you access some equity in your own home loan? You can either put in an additional contribution or loan it to the SMSF as a second ‘member financed’ loan in addition to the edges loan.
- Read my other article “Under 35? Five Simple Things You Can Do Now to raise Your Superannuation Savings”
If you don’t have the money obtainable now – look on the bright side – you can use your time educating yourself so when you do have the money you will make informed decisions.
Negative Gearing: 2 SMSF: 3
Fifth Match – current Costs:
When you own an investment character on your own name, you need to complete a rental character schedule as part of your yearly income tax return. Most people can do this themselves or if they include an accountant to complete their tax return it simply adds a bit more to the annual fee they have to pay.
By comparison a SMSF is a whole other entity. You annual administration costs are typically between $1,000 and $3,000. There are ways to make your annual administration costs towards the lower end of this range however.
Negative Gearing: 3 SMSF: 3
Sixth Match – Asset Protection:
Although this is probably not applicable if you are a typically salary and wage earner, asset protection is very important for small business owners (and future small business owners).
If you function a business and you have an investment character in your personal name, if someone tries to sue you that character is at risk. By comparison any assets owned by your SMSF are untouchable.
Negative Gearing: 3 SMSF: 4
Seventh Match – Death, Divorce and the Bank:
What happens when things go wrong?
When you die, assets in your personal name become part of your estate which are afterward distributed to your beneficiaries (spouse, children etc) under the supervision of the executor as per your Will. In general there is no tax.
The treatment of your super when you die is a little different – there are both advantages and disadvantages.
Superannuation, like an investment character held in your own name is part of your matrimonial assets – meaning it needs to be divided between the divorcing parties. When a SMSF that only holds character and cash is involved, the typical course of action is to sell the character, pay off any loan(s) and move each party’s interest to a separate fund (SMSF or retail / industry fund).
Whether the character is owned personally or in an SMSF, if you can’t make the loan repayments the bank has you over a barrel. If everything does go wrong and the bank re-possesses the character and sells it as the mortgagee if the character is in your own name, you may have to fork out to pay any costs that the sale doesn’t cover.
By comparison, the SMSF loan has to be ‘limited recourse’ meaning they bank only can access the proceeds from the sale of the character – not any other assets of the SMSF or from you personally. Also with the SMSF loans requiring higher deposits (lower LVRs) it is less likely the sale proceeds wouldn’t cover the loan repayment and associated bank legal costs.
Negative Gearing: 4 SMSF: 5
In general, purchasing an investment character via a SMSF is going to be better strategy compared to buying it your personal name.