UNDERSTAND YOUR INVESTMENT OPTIONS AND RESTRICTIONS USING SMSF FUNDS
Your investment strategy is critical to the success of your SMSF and needs to be carefully managed to ensure the retirement benefits of members are protected. By law, you must create and implement an investment strategy that takes into account the financial circumstances of the fund.
You must then consider any investment in light of this strategy. The strategy should set out your objectives and how the trustees will achieve these objectives, including consideration of and reasoning behind decisions on:
- Cash flow
- Benchmarked returns
- Composition of investments
- Levels of diversification and risk
- Liquidity of investments
- The ability of the fund to discharge existing and potential liabilities
There are a number of laws and regulations you will need to consider when investing through your SMSF, in addition to the obligations required of you as a trustee. These rules ensure that you act responsibly, honestly and in the best interests of all members, and invest with care, skill and diligence.
SMSF is the only superannuation option that allows you to invest in direct property, rather than indirectly through unlisted property trusts, Real Estate Investment Trusts (REIT) or managed funds that hold property assets. For this reason, residential and commercial property is a common investment choice among SMSF trustees.
You can also invest in shares, as well as alternative investments such as a members’ business premises, unlisted shares, artwork or collectibles. In some circumstances, you can also borrow to invest in assets held in your SMSF, which generally isn’t possible in large super funds. Any investments you make must be for the sole purpose of providing retirement benefits to members once they stop working, after they reach 65, or to their dependents in the event of their death. This means that members, relatives or related parties must not gain immediate benefits from the funds in your SMSF or its activities.
For example, a private property owned by the SMSF can’t be used by members or their families, even if they pay market rent. Investments must be made on an arm’s length basis, which means the asset must be bought or sold at full market value and on commercial terms. Any income received from the investment must be valued at the true rate of return and any interest paid on limited recourse borrowings must be at market rates for similar types of loans.
The Superannuation Industry (Supervision) Act 1993 prohibits certain types of investments.
The following four rules cover these restrictions.
1. SMSFs cannot lend money or provide financial assistance
Your SMSF fund cannot lend money or provide financial assistance to a member or a member’s relative, including loans. There are no exceptions to this rule. A relative is considered a parent, grandparent, sibling, uncle, aunt, nephew, niece, child or adopted child of the member or their spouse, as well as any spouse of the member or their relatives.
2. SMSFs cannot borrow money, except in limited circumstances
Your SMSF cannot borrow money, except to fund a payment to a beneficiary or pay a surcharge liability, cover the settlement of securities transactions, or acquire an asset under a Limited Recourse Borrowing Arrangement (LRBA). These loans are only available for short timeframe and there are limits on the loan value, so it’s important to talk to your SF Wealth financial adviser before borrowing to ensure you don’t breach this restriction.
3. SMSFs cannot acquire an asset from a related party, except in limited circumstances
Your fund cannot acquire an asset from a related party, which includes members of your SMSF and their relatives, business partners, the spouses or children of the business partners and any trust or company controlled or influenced by a member. This means you can’t sell your private home to the SMSF or acquire a property owned by anyone related to your fund. There are a few exceptions. One is listed securities such as shares and bonds, provided they are quoted on the Australian Stock Exchange (ASX) or an approved international stock exchange. Another is business real property, which is property used exclusively by one or more businesses. An investment property or holiday home does not qualify as business real property. Other exceptions include investments in a widely-held trust, such as a managed fund, as well as investments in an in-house asset of the SMSF, provided it does not breach five percent of the total value of the fund. All investments must be acquired at full market value or on an arm’s length basis and form part of your SMSF investment strategy.
4. SMSFs must limit in-house assets to five percent of the fund’s value .An in-house asset is an investment or loan to a related party or trust of the fund. For example, if a member provides a loan to a company in which they are an employee, it would be considered an in-house asset. This also includes assets owned by the fund that are leased to a related party. The in-house assets held in your SMSF must not exceed five percent of the total market value of your fund. It’s important to watch the value of your fund and its in-house assets, as you could be liable if their values fluctuate.
Business real property is also exempted from the in-house assets rule, which means your SMSF can own your business premises and lease it to a member on an arm’s length basis. To create an investment strategy that’s accepted by the relevant laws and regulations and complies with all investment restrictions, talk to your SF Wealth financial adviser.
This information is general in nature and does not take into consideration your personal circumstances. Talk to your SF Wealth financial adviser for SMSF advice that’s right for you.