Limited Recourse Borrowing and Your Self Managed Super Fund

The Keating Government introduced a compulsory Superannuation Guarantee and significantly reformed Australia’s retirement income policies. Consequently, all Australians must deal with managing their superannuation.

Many Australians choose to manage a Self Managed Super Fund (SMSF), especially those with a high level of finance and investing. Limited Recourse Borrowing (LRB) is an option you may consider for your SMSF. Like any investment, however, you should not make the decision lightly. Below, we’ll outline what LRB borrowing is, as well as the relevant law.

Limited Recourse Borrowing

LRB requires an SMSF trustee to take out a loan from a third-party provider (such as a bank), which is then used to purchase an asset. The asset must be held in a separate trust to the SMSF trust. Separating SMSF trusts and LRB trusts protects assets. If the LRB loan defaults, the lender’s rights are limited to the asset pool contained in the separate trust, with no recourse to the assets held by the SMSF.

What Should an SMSF Trustee Think About When Considering LRB?

When making an investment decision, a trustee should consider the usual factors, including: 

• Who will be the lender? 
• What will happen if interest rates lower or rise? 
• Does the loan allow a borrower to pay less if rates decrease? 
• Can the loan be called in early? 

A trustee must also consider the quality of the investment itself, in addition to the loan’s characteristics.

While a trustee should consider all the factors typical in making any other investment, a trustee does have an extra duty concerning trust assets. A trustee has a duty to preserve and protect trust property (see Alsop Wilkinson v Neary [1995] 1 All Er 431). A trustee also has a duty to exercise their powers in the best interests of the present and future beneficiaries of the trust.

Finally, the trustee of an SMSF needs to consider the impact of section 67A and section 67B of the Superannuation Industry (Supervision) Act 1993 (Cth) on a LRB arrangement. This section allows a trustee of an SMSF to borrow money, which the Act otherwise would prohibit. Also relevant is the date that the parties entered into the LRB arrangement. Different laws apply if the parties entered into the arrangement on or after 24 September 2007, and before 7 July 2010, compared to an arrangement entered into before or after this time period.

Key Takeaways

In conclusion, using a LRB arrangement may be a viable arrangement for a SMSF. However, a trustee needs to consider whether the investment itself offers a quality return and whether loan terms are suitable. A LRB arrangement must also meet the requirements set down by section 67B and section 67A of the Superannuation Industry (Supervision) Act 1993 (Cth).

Questions? Get in touch on 1300 544 755.