Thinking about using your SMSF to borrow to invest? SMSF borrowing has become a popular way of maximising retirement savings because it allows you to increase the amount available to invest within your SMSF.
SMSFs are generally not allowed to borrow money. However there are some limited exceptions including borrowing to invest under a specific type of borrowing arrangement called a ‘limited recourse borrowing arrangement’ (LRBA).
What is an LRBA?
An LRBA is a type of loan structure designed for SMSFs that involves establishing a ‘holding trust’ (also called a ‘bare trust’) where the trustee of this trust (also known as the custodian) legally holds the asset on behalf of the SMSF trustee/director.
The borrowing must be on a ‘limited recourse’ basis for the purpose of acquiring an asset that is held on trust until the borrowing has been repaid. This means the lender’s recourse is limited to the asset being bought under the arrangement. For example, if your SMSF is unable to meet its loan obligations, the bank can only access the asset that was purchased using the loan (ie, the bank cannot take other assets of the fund).
However, to protect themselves from this happening, most banks require you to provide a personal guarantee for the loan so that in the event of a default, the bank would seize your personal assets given that they can’t access your SMSF assets. This potential personal exposure should be factored in when contemplating entering into an LRBA.
The holding trust
As mentioned above, a LRBA involves establishing a ‘holding trust’ for the sole purpose of legally holding the asset on behalf of the SMSF for the duration of the loan. This holding trust arrangement recognises that the asset is to be held by the trust until the debt is repaid, at which point legal ownership can pass to the SMSF.
The asset that is held on trust for the SMSF must be an asset that the SMSF would be permitted to invest in directly. In most cases, an LRBA is used to purchase real property. However, it may also be possible to purchase a parcel of shares in the same company or units in a managed fund using an LRBA, subject to certain conditions being met.
