An SMSF is essentially a private superannuation fund that you manage yourself, giving you greater control over where your retirement savings are invested. Unlike traditional superannuation funds that pool the savings of many individuals, an SMSF is run by up to six members, all of whom are also the trustees of the fund. And as SMSF trustees, you have full responsibility for complying with the rules and laws governing superannuation.
So, there are a few important steps that you need to take to setup SMSF for your property investment.
Step 1 – Determine if an SMSF is Right for You
Before anything, ask yourself: Is setting up an SMSF really what I want? And is that something I see myself managing effectively?
This is important because managing your own super fund is a huge responsibility and not a decision you can afford to take lightly. At the very least, you’ll need a good understanding of finances, plenty of time, and a willingness to stay on top of your investments.
So, other questions to ask yourself:
- How confident are you in your investment skills? Are you able to research property markets, manage loans, and understand tax implications?
- Will you be able to make the time commitment of managing an SMSF and give it ongoing attention, especially when you plan to borrow money for property investments?
- What is your perceived risk tolerance in case the property market dips and your retirement savings could take a hit?
So, because you have a lot to figure out before proceeding, you can consider having a chat with a licensed financial advisor at AxJ Finance Brokers. They’ll help you understand whether this is the right path for your retirement strategy and talk through some risks you might not have considered.
Step 2 – Choose Your Trustee Structure
Once you’ve decided that an SMSF is the way to go, the next step is to choose a trustee structure. There are two main types to choose from – Individual Trustees and Corporate Trustees.
Individual Trustees
- An SMSF can have a minimum of 2 and a maximum of 6 individual trustees.
- All individual trustees must also be members of the SMSF.
- Assets must be held in the names of all individual trustees as trustees for the SMSF.
- Less expensive to set up compared to a corporate trustee structure
Corporate Trustees
- The SMSF has a company as its trustee, and all members of the SMSF must be directors of the company.
- Greater flexibility with estate planning and membership changes.
- Costs more to set up initially, but it can save hassles down the road.
Generally, a corporate trustee structure is the preferred route for property investment since it provides flexibility in case you want to change members without the need to retitle assets. Plus, if you ever breach any regulations, penalties apply only to the company, not the individual trustees, so you are in the safe zone.
Step 3 – Set Up a Trust Deed
The next step is to create a trust deed, which is a legal document that outlines how your SMSF will operate. It will work as your guide – covering areas like:
- How contributions are made.
- How benefits are paid out.
- The specific powers and responsibilities of the trustees.
So, it’s crucial to have your trust deed drafted by a lawyer or a professional who specializes in superannuation law. This is because if your deed doesn’t comply with superannuation laws, your SMSF may not qualify for tax concessions, and you could face hefty penalties – better safe than sorry!
Step 4 – Register Your SMSF
Next, you’ll need to register your SMSF with the Australian Tax Office (ATO). You will need to do the following:
- Obtaining an Australian Business Number (ABN).
- Getting a Tax File Number (TFN) for your SMSF.
- Ensuring that your fund meets the requirements of an “Australian Super Fund” to access the concessional tax rate of 15%.
The ATO will review your application, and once everything is in order, you’ll officially have an SMSF!
Step 5 – Develop an Investment Strategy
This is where things get interesting and complicated. With your SMSF set up, it’s time to develop a solid investment strategy that aligns with your retirement goals. Since we’re on the topic of property investments, your strategy should consider factors such as risk tolerance, liquidity, and the importance of diversifying your portfolio. It’s also beneficial to explore investment loans tailored to SMSFs, which can enhance your purchasing power. Additionally, keeping an eye on refinancing opportunities can help you optimise your portfolio and improve cash flow over time.
Step 6 – Open a Bank Account for the SMSF
Now, it’s not a surprise that your SMSF will need its own bank account, separate from your personal accounts. This account will be used to manage all the fund’s financial transactions—receiving contributions, making investments, and paying for expenses like audit fees and property maintenance.
Step 7 – Obtain an Electronic Service Address (ESA)
An Electronic Service Address (ESA) is basically a digital mailbox for your SMSF. Along with a separate bank account, this is also an important component of SMSF setup. It’s necessary for receiving contributions from employers and handling rollovers between superannuation funds electronically. So, in simple terms, the ESA makes sure that your SMSF can communicate with the ATO and other superannuation providers in a secure and efficient way.
Step 8 – Secure Finance/SMSF Loans
Now that your SMSF is set up, it’s time to think about securing finance for your property purchase. For this, you’ll need to use a Limited Recourse Borrowing Arrangement (LRBA), which means the loan is secured against the property, but only that property. If things go south and you can’t repay the loan, the bank can only claim the property and not other assets in your SMSF. This is favourable for you, but it requires extra caution:
- You can’t buy a property from a related party.
- The property must be a single asset or a collection of identical assets that have the same market value.
- You can’t improve the property with borrowed money; it can only be maintained.
Common Mistakes People Make with SMSF Loans (and How to Avoid Them)
Investing in property through an SMSF can be a great way to build wealth, but things can get a bit overwhelming. And it’s common to see people make mistakes. There is nothing wrong with that, but a good idea is to learn from the mistakes others have made and prepare to avoid them altogether.
1. Failing to Understand SMSF Borrowing Rules
As we have established so far, SMSF loans come with a long list of rules. Many people get tripped up because they don’t fully understand these restrictions, such as the inability to improve a property with borrowed funds. To avoid this, make sure you do your homework or consult a mortgage broker familiar with SMSF law.
2. Not Allowing for Sufficient Liquidity
Investing heavily in property can tie up a significant portion of your SMSF’s funds, making it difficult to pay for other expenses like pension payments, tax liabilities, or repairs. So, make sure your SMSF has enough liquid assets, especially cash, to cover ongoing costs.
3. Failing to Structure Loans Correctly
Improper loan structuring is also a major error. It’s important to set up the loan under a Limited Recourse Borrowing Arrangement (LRBA) to protect other assets within your SMSF. This is one of the features that differentiates SMSF loans from traditional property loans, and you need to be vigilant to take advantage of that!
4. Overcommitting Financially
Some trustees fall into the trap of overleveraging their SMSF, which means that they end up buying properties they can’t realistically afford. Remember, the more you borrow, the higher your risk, especially if property values decline. So, balance is the key here!
5. Ignoring Compliance Obligations
Failing to comply with superannuation laws can lead to significant penalties. For example, SMSF trustees often forget about required audits or fail to keep proper records of their SMSF’s activities. To avoid this, keep detailed records and consult an SMSF expert to stay ahead of things.
Conclusion
Setting up an SMSF for property investment isn’t the easiest thing out there. But, for those willing to put in the time and effort, it can be an effective way to take control of your financial future.
So go ahead, take control—but do it smartly!