Why borrowing to invest with an LRBA is popular
Borrowing to invest is a popular way of maximising retirement savings because it allows you to increase the amount available to invest within your SMSF.
An LRBA is different to a normal loan in that if the borrower (the SMSF) defaults on the loan, the lender’s recourse (ie, what they can take instead) is limited to the asset being bought under the arrangement.
For example, if a bank lends money to your SMSF to buy a property and the fund defaults on the loan, the bank cannot take other assets of the fund. To protect themselves from this outcome, most banks require you to provide a personal guarantee for the loan (so in the event of a default, the bank would seize your personal assets given that they can’t touch your fund).
What are the rules when using an LRBA?
We recommend specialist advice before proceeding with an LRBA, here are some things to consider beforehand:
- The borrowed money can only be used to buy one asset (e.g. one property). If you wish to buy several assets, you will need several LRBAs.
- An exception to this requirement is that you can buy a collection of identical assets (e.g. shares in a single company) under a single LRBA but only if you always deal with them as a block. For instance, you couldn’t sell just some of them, you would have to keep them all or sell them all (and pay off the loan).
- Legally, the assets under an LRBA are actually bought on trust for the SMSF by a custodian. The SMSF still receives any income (e.g. rent) from the asset and pays the expenses relating to the asset (e.g. rates), but does not hold legal title until the loan is paid off and the title is transferred from the custodian to the SMSF trustees.
- The loan can generally only be used to buy new assets, it can’t be used to improve a property already owned by the SMSF.
- There are rules about what you can do to the asset while a LRBA is in place. For example, you can’t change it so radically that it effectively becomes a completely different asset (e.g. knocking down a house and replacing it with flats or building a house on a vacant block of land).
These rules will cease to apply once the borrowing has been repaid and the LRBA has been wound up.
The LRBA loan doesn't have to come from a bank
It may be structured so that (say) the SMSF member themselves, or another entity like their family trust, is the lender. These are called “related party” LRBAs. The real challenge with a related party arrangement is making sure they operate on a truly commercial basis – ie, the terms are all the same as they would be if the lender and the SMSF were operating at arm’s length. This often means getting a comparable offer from a bank or adopting some “safe harbour” rules put out by the ATO. Unfortunately the safe harbour rules don’t cover every type of lending arrangement and they need to be followed to the letter if you want to rely on them. You can learn more about one feature of these safe harbour rules – the interest rate – here.
