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.

Advantages:

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:

• Most investors have access to a lump sum for investment due to the compulsory superannuation scheme in Australia.
• Borrowing inside super provides access to a tax concessional environment, as income earned from assets of the fund is taxed at a minimum rate of 15%. Capital gains are also taxed at a maximum of 15%, but only at 10% if the asset has been held for over 12 months. Once a super fund moves to pension phase, any gains are exempt from both CGT and income tax.
• Superannuation funds are entitled to imputation credits from investing in shares of companies. As companies pay tax at the rate of 30%, the fund may be eligible for a refund of excess imputation credits due to only 15% tax payable on investment earnings in a complying super fund.
• For specific groups such as small business owners, borrowing through their super fund can provide specific advantages, such as the ability to purchase business real property and lease this back to their business as an office premises. This also means they can put in deductible contributions to the super fund. Rent can also be directed into their SMSF, giving two sources of income to the SMSF.

Disadvantages:

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.

Inside Vs Outside

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.