Self-Managed Superannuation Funds (SMSFs) provide individuals with greater control over their retirement savings, but strict regulations govern how funds can borrow money. The Limited Recourse Borrowing Arrangement (LRBA) is the primary structure that allows SMSFs to borrow, and it comes with specific compliance requirements. Understanding the rules around SMSF borrowing is essential to avoid costly mistakes and ensure a compliant investment strategy.
Can an SMSF Borrow Money?
Under Australian superannuation law, SMSFs generally cannot borrow money except in limited circumstances. The primary exception is through an LRBA, which allows SMSFs to borrow for asset purchases while ensuring that recourse is limited to the asset itself. Other borrowing exceptions exist for short-term liquidity purposes, but these are strictly regulated.
Limited Recourse Borrowing Arrangements (LRBAs)
An LRBA is a loan structure where an SMSF borrows funds to acquire an asset, with the loan secured solely against that asset. If the SMSF defaults on the loan, the lender only has recourse to the asset purchased with the borrowed funds, protecting other superannuation assets.
Key Rules for SMSF Borrowing Under an LRBA
To ensure compliance, SMSFs must adhere to the following:
- The asset must be held in a separate trust – The acquired asset must be held in a bare trust (holding trust) until the loan is repaid.
- The loan must be ‘limited recourse’ – The lender can only claim against the asset and cannot pursue other SMSF assets.
- Only one asset per loan – SMSFs cannot bundle multiple assets under a single LRBA.
- Loan terms must be commercial – The loan must be on arm’s length terms, ensuring that interest rates and repayment terms align with market conditions.
- The asset must be a permissible investment – The purchase must comply with the SMSF’s investment strategy and the sole purpose test.
What Can an SMSF Borrow Money For?
SMSFs can only borrow to acquire certain assets that fit within the fund’s investment strategy. Commonly acquired assets include:
- Residential or commercial property (must not be used by fund members or related parties unless it qualifies as business real property).
- Shares and managed funds (subject to loan structure compliance).
- Farmland and other eligible investments.
Prohibited Borrowing Purposes
An SMSF cannot borrow to:
- Refinance an existing SMSF property loan.
- Fund renovations or construction (borrowed funds can only be used for purchasing an asset, not improving it).
- Provide financial assistance to fund members or related parties.
Alternative Borrowing Exemptions for SMSFs
While LRBAs are the main borrowing structure, SMSFs can also borrow under these limited conditions:
- Temporary borrowing for liquidity management – SMSFs can borrow for up to 90 days to cover benefit payments or meet settlement obligations.
- Installment warrants – Some investment structures allow SMSFs to gain exposure to assets in a staged manner, subject to strict conditions.
Risks and Compliance Issues
SMSF borrowing comes with risks, and trustees must ensure they comply with ATO guidelines and the Superannuation Industry (Supervision) Act 1993 (SIS Act). Key risks include:
- Breaching the sole purpose test – If the loan benefits a member or related party, the fund could lose its complying status.
- Non-commercial loan terms – Loans from related parties must meet safe harbour guidelines to avoid penalties.
- Inappropriate asset selection – If the purchased asset is not in line with the fund’s investment strategy, trustees may face compliance breaches.
Final Thoughts
Borrowing within an SMSF can be a powerful investment strategy when used correctly, but strict rules govern its use. Trustees must ensure that loans are structured correctly, meet regulatory requirements, and align with the fund’s investment strategy. Given the complexities involved, seeking professional advice is highly recommended before entering into an SMSF borrowing arrangement.