Building wealth for retirement is a priority for many investors. To assist this process, borrowing to invest – also known as gearing – is a popular way of increasing exposure to growth investments and gaining the potential for higher returns.
Changes to legislation in 2007 and 2010 now means that it’s now possible for investors to borrow within superannuation, and this can be a viable strategy for many investors.
Borrowing to invest inside super can provide investors with the best of both worlds – a tax concessional environment and accelerated returns. However, while it can be beneficial, gearing also involves a higher degree of risk and can magnify losses as well as gains.
The main advantage of borrowing to invest is that investors are provided with a large asset base and, therefore, greater potential for returns if the value of the investment rises. Other advantages include:
The main disadvantage of gearing is the higher financial risks faced by the investor.
For investors that choose to gear outside of superannuation through a margin loan, they face the risk of a margin call should the value of the geared investment fall to such an extent that the loan to value (LTV) ratio rises above a specific level as set by the lender.
Borrowing inside super also places greater restrictions on the types of loans and assets that can be acquired. The Superannuation Industry (Supervision) Amendment Act 2010 states that loans must be of a limited recourse nature and only a single asset or group of identical assets can be acquired with borrowed funds. If purchasing property, the property cannot be a specialised property (e.g. hotel/childcare centre) The ATO also take the view that the loan cannot be refinanced during the loan term.
In addition, once an asset has been purchased by a super fund, the wealth is locked inside superannuation until the member satisfies a condition of release such as reaching retirement age.
Whether you’re better off borrowing inside or outside super can depend on several factors – how much risk you want to take, the investment horizon, as well as the type of assets and gearing arrangements.
Speak to your advisor to determine the best strategy for you personally.
PJT offers free consultations with our Superannuation experts.