Clik here to view.
SMSF limited recourse borrowing must stop
The Australian 12:00am February 19, 2018
Glen McCrea
Glen McCrea is chief policy officer at The Association of Superannuation Funds of Australia.
Volatility in equity markets recently is a useful reminder not to put all your eggs in the one basket. It tells us that what goes up can go down rapidly.
This reminder also applies to the quarter-acre block or the apartment off the plan. The low-interest environment in recent years has helped fuel demand for property by investors, including mums and dads and self-managed superannuation funds.
A risk to the retirement savings of individuals and a structural risk to economy have been created because many SMSFs are borrowing to purchase property.
This borrowing grew 50 times, from $497 million in June 2009 to $25.4 billion by June 2016. More than 90 per cent of it related to property.
Growth by 5000 per cent over seven years is astonishing and, as custodians of the super system and the peak super industry group, the Association of Superannuation Funds of Australia considers this type of borrowing needs to stop now.
The ability of SMSFs to borrow arose from the privatisation of Telstra around a decade ago.
Lots of SMSFs had purchased instalment warrants in Telstra — a form of borrowing — in advance of owning the shares. To stop funds unintentionally breaching the law, the government allowed those funds to borrow in certain circumstances (known as limited recourse borrowing).
The number of SMSFs borrowing is rising. Over the five years to 2016, SMSFs with borrowings increased from 4 per cent to 9 per cent.
The average amount borrowed also increased by 4 per cent, from $356,000 to $372,000.
Around 42,000 SMSFs currently borrow, mostly to buy property. More than half the SMSFs making use of limited recourse borrowing have more than 80 per cent of the fund’s total assets supported by such borrowing.
If the property bubble in Sydney and Melbourne bursts, the government could come under pressure to bail out SMSFs to prevent people losing retirement savings. There also would be an increase in expenditure on the Age Pension due to lower retirement savings.
While property is a legitimate asset class for super funds, allowing self-managed funds to borrow to invest in property adds risk to the economy as well as directly to those funds.
When prices are rising, SMSF returns are higher due to the ability to borrow. However, borrowing also magnifies losses.
Normally super funds use diversification strategies to reduce risk and they invest in a range of assets like shares, cash, bonds and property. Diversification, as shown in the GFC, means that even when some assets fall in value, you can ride it out provided you don’t need the money urgently for something else.
When SMSFs borrow and are concentrated in a limited number of assets, they can be forced to sell assets when they fall in value, either to meet interest payments or because the lender has to foreclose on the property. In addition, the SMSF trustee may need to start accessing the age pension, meaning taxpayers end up bearing the costs of that investment decision.
The government’s recent inquiry, led by former CBA CEO David Murray, had the foresight to call for a stop to this form of borrowing. And the Association of Superannuation Funds of Australia has continually highlighted the need to stop this type of investment.
The latest ATO statistics and the state of the property market mean now is the time to act.
Given the contractual arrangements currently in place and the difficulties associated with forced sales of more than $25bn in assets, any changes to the law could be grandfathered, at the same time removing the ability to enter into such borrowing arrangements in the future.
The Australian Prudential Regulation Authority, the Reserve Bank and federal and state governments continue to work to address concerns over housing affordability and ensure Australia has a soft landing from property price bubbles in Melbourne and Sydney.
A sensible reform in this year’s budget would stop SMSFs gambling with their super.
NOW IS THE TIME TO ACT!