LRBA Changes May Hinder SMSF Gearing

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In the last decade, many SMSFs have used a “limited recourse borrowing arrangement” (LRBA) as part of a gearing strategy to build members’ retirement savings. An LRBA is a special type of loan that allows SMSF trustees to borrow to buy an asset – typically real estate. Gearing strategies have been particularly attractive to SMSF members who feel constrained by the current contributions caps.

However, proposed laws currently before Parliament will create some new planning issues for LRBAs.

Under these proposals, an SMSF’s outstanding LRBA loan balance will, in some cases, be taken into account when calculating a member’s total superannuation balance (TSB).

This means some members’ TSBs will increase, which may have significant consequences for the members and the fund. If enacted, these laws will apply to any new LRBAs entered into on or after 1 July 2018.

Why is a member’s TSB important?

A member’s TSB is a calculated amount that essentially reflects the value of all their superannuation interests – broadly, both their accumulation and retirement phase interests. It is an important concept for all fund members because it is used as a threshold to qualify for various superannuation measures, including:

  • whether you may make non-concessional contributions (NCCs);
  • for members under age 65, whether you may trigger a “bring forward” arrangement of up to two or three years’ worth of the annual NCC cap;
  • your eligibility for other contributions measures such as government co-contributions, the tax offset for spouse contributions, “catch-up” concessional contributions and a 12-month exemption from the work test for recent retirees; and
  • whether your SMSF may choose, for tax purposes, to earmark particular fund assets as pension assets so that the income earned from those specific assets is tax exempt while the fund is paying a pension.

How will an LRBA affect a member’s TSB?

Under the proposed new laws, a member’s proportionate share of their SMSF’s outstanding LRBA loan balance will be included in their TSB if the asset acquired under the LRBA supports (to some extent) the superannuation interests of that member and either:

  • the member has satisfied one of the following conditions of release: retirement, terminal medical condition, permanent incapacity or attaining age 65; or
  • the lender under the LRBA is an “associate” of the fund (in practical terms, a related party).

As explained above, an increase in a member’s TSB can have many consequences because the TSB is an eligibility threshold for many superannuation measures. Perhaps most importantly, if an SMSF will rely on members’ contributions to help fund its LRBA loan repayments, the SMSF might have difficulty repaying the loan if one or more members becomes ineligible to make NCCs (or to “bring forward” as many NCCs as originally planned) or to make other types of contributions such as “catch-up” contributions because of a member’s TSB increase. This liquidity issue might also affect the SMSF’s ability to meet its other liabilities, such as minimum annual pension payments.

Planning a borrowing? 

If you are considering an SMSF borrowing strategy or need to review an arrangement already put in place on or after 1 July 2018, contact us to discuss how the proposed new laws will affect you. We can help you to quantify the impact, plan for any liquidity issues that may arise and explore refinancing or other necessary strategies.