Offset accounts linked to SMSF loans can provide substantial financial benefits through interest savings, provided they are structured correctly, and the loan documentation allows. However, the complex nature of limited recourse borrowing arrangements (LRBA) necessitates careful consideration of the setup of offset accounts to avoid regulatory pitfalls.
Understanding SMSF Loans
Section 67A of the Superannuation Industry Supervision (SIS) Act 1993 permits trustees to borrow under specific conditions known as a limited recourse borrowing arrangement (LRBA). In an LRBA, a separate bare trust holds the SMSF property or other assets. If the trustee defaults on the loan, the lender's recourse is limited to the asset held in the bare trust, thus safeguarding the remaining assets of the SMSF.
The Pitfalls of Redraw Facilities in SMSFs
A redraw facility enables borrowers to make extra repayments on their loan and redraw them if needed. Although beneficial in reducing interest payments, redraw facilities are problematic under SMSF regulations as they release equity the SMSF Trustee has built up in the Fund asset. As such section 67 of the SIS Act restricts the release or use of equity from SMSF properties, making redraw facilities non-compliant when linked to SMSF loans.
The Compliance of Offset Accounts
Unlike redraw facilities, offset accounts are compliant and beneficial for SMSFs. An offset account reduces the loan balance for interest calculation without actually decreasing the loan principal. For example, if a $100,000 loan has $10,000 in an offset account, interest is calculated on $90,000, not $100,000. The money in the offset sits in the bare trust and is NOT part of the assets of the Fund - this is crucial!!!
Examples Highlighting the Differences
Offset Account Example: A trustee of an SMSF has a property loan of $300,000 with a linked offset account containing $50,000. Interest is only calculated on $250,000, leading to significant savings without affecting the loan's principal, maintaining compliance with SMSF regulations.
Redraw Facility Example: A trustee initially borrows $300,000 and repays $50,000 over time, reducing the balance to $250,000. If the trustee redraws $20,000 for emergency expenses, the loan balance returns to $270,000. This act of redrawing contravenes SMSF rules as it is considered releasing equity, which is prohibited under LRBA provisions.
The Strategic Use of Offset Accounts
In the current high interest environment, maintaining liquidity and cash reserves is vital yet often unproductive. An offset account allows SMSF trustees to hold necessary cash while effectively earning an interest rate equivalent to the mortgage rate, significantly enhancing cash flow. Additionally, the interest savings are not considered taxable income, providing a tax-efficient strategy for managing SMSF finances.
Ensuring Compliance
It's advisable for trustees to regularly review their SMSF loan structures, especially if they include features like offset accounts or redraw facilities. Non-compliance can lead to significant penalties and the loss of tax benefits. For SMSF trustees unsure of their loan structure's compliance or Trustees seeking to upgrade their documentation, consulting with a specialised SMSF lawyer such as those at Abbott and Mourly Lawyers can provide clarity and guidance, ensuring that their SMSF operates within the legal framework and continues to benefit from its intended tax advantages.
Contact nush@abbottmoulry.com.au for more details.