When used correctly, offset accounts can have huge benefits for SMSF loans. However, due to the complex nature of limited recourse borrowing arrangements (LRBA), there are dangers to offset accounts if they’re not structured correctly.
How does an SMSF loan work?
The Superannuation Industry Supervision (SIS) Act 1993 prohibits trustees from borrowing money to invest in super unless the loan is structured as a limited recourse borrowing arrangement (LRBA). This is in part due to the restrictions around using superannuation as security for a loan.
With an LRBA, a Bare Trust is established to own the SMSF property (or other asset) on behalf of the super fund. With the asset sitting in a separate trust, if a trustee defaults on the loan, the lender can only take the asset in the Bare Trust — providing limited recourse and protecting the other assets of the SMSF.
This complex structure means that any equity in the SMSF properties can not be released or used as security for separate purchases.
Dangers of a Self-managed super fund redraw facility
A redraw facility is a common home loan feature that allows the borrower to make additional mortgage repayments to reduce the principal of the property loan and essentially reduce the amount of interest payable. If the borrower needs to access some cash, they are free to withdraw money they’ve contributed to the redraw facility.
While redraw facilities are an effective feature to reduce the amount of interest on a mortgage, they contravene section 67 of the SIS Act. As discussed above, under an LRBA, a borrower cannot use or release equity from their mortgage. Redrawing funds from a mortgage is essentially withdrawing equity, and is not allowed.
Difference between an offset account and redraw facility
Using a redraw facility attached to an SMSF loan could see you face compliance action. However, an offset account — which essentially provides the same benefits — is allowed.
Offset account. An offset account is a transaction account attached to a mortgage. Any amount sitting in the offset directly reduces the balance of the loan for interest expense purposes. For example, if you have a mortgage for an investment property with a balance of $100,000 and $10,000 sitting in an offset account, the interest expense will be calculated on the loan’s balance minus the amount in the offset ($90,000 instead of $100,000).
Redraw facility. A redraw facility allows the borrower to make additional loan repayments and redraw the amount if they need the funds. For example, if the loan balance is $100,000 and they repay an additional $10,000, the balance of the loan will be $90,000. If the borrower needs to access the extra $10,000, they are free to do so — unless, of course, it’s an LRBA. In that case, the extra $10,000 payment is considered equity and cannot be compliantly redrawn.
The key difference between the two features is that any amount in an offset doesn’t pay down the loan amount — it only offsets the amount of interest calculated —. In contrast, money paid into a redraw facility directly reduces the loan amount, so redrawing an amount is considered to be accessing equity.
Benefits of an offset account for an SMSF loan
SMSFs generally invest in cash assets or hold cash reserves to cover liquidity requirements and SMSF expenses like taxes, insurance premiums and administration costs. As we all know, interest rates are currently the lowest they’ve ever been, meaning a savings account or term deposits will generate a return not much higher than zero. Many SMSFs need to be holding cash, but at close to zero return, it’s a waste of potential.
An offset account allows you to hold cash for liquidity reasons while effectively earning a return equivalent to your mortgage interest rate. While you’re not actually earning a return, you are reducing your interest expenses — which has an added cash flow benefit because you’re not being charged income tax on any earnings in an offset account, and the interest expense may be tax-deductible.
Is your offset account compliant?
If your SMSF loan has an offset account or redraw facility, it might pay to review it. If your SMSF is found to be non-compliant, you could face losing any tax benefits associated with your fund. It’s a costly mistake!
We can help you access SMSF loans with a compliant 100% offset account. It’s as simple as reviewing and refinancing your SMSF loan. And with some great fixed rate and variable rate investment property loans on offer, it’s a great time for a review.
Book your free review to learn how much money you could potentially save by refinancing and utilising an offset account for your self managed super fund. Or simply get in touch if you’d like to learn more about SMSF lending.