The rules governing what you can and can’t do with the funds in your SMSF can be quite complicated and at times, difficult to understand. Before we delve into these a little further, let’s look at the legal requirements of the trustees of the fund first.
When the SMSF fund is first established it must have an investment strategy which must be in writing. This strategy should consider the age, employment and retirement needs of its members. It must also carefully consider the level of risk associated with any one particular investment.
Most SMSF advisors would agree that there should be diversification within the investment strategy so that all the funds are spread over several investments to minimise the risk of loss. The trustees must also remember that the SMSF will need ready access to cash to pay for things like administrative expenses, income tax and minimum income stream payments if there are any due to members of retirement age.
It’s also important and a legal requirement, that the investment strategy is reviewed on a regular basis to ensure that it’s still meeting the needs of its members. Events which can prompt a review include when a new member joins the fund or an existing member leaves the fund, and when the fund starts to pay an income stream to one of its members.
Any review must be documented, as well as any changes that have been made. This is so that the SMSF auditor can verify that the changes are compliant. In fact, there are penalties for failing to keep records and these will need to be paid by the trustees.
Now Lets Consider The Rules Regarding Investments
According to the ATO, any investments which are made by an SMSF must be on an ‘arms length’ basis. What this means is that all fund assets must be bought and sold at market value. And any income that the fund earns should show a true market rate of return.
To explain this even further, the fund needs to have clear ownership of its investment assets and these must be kept separate from the members’ personal assets. It’s also important to note that all the fund’s assets must be held in the name of the SMSF fund and cannot be held in the name of a trustee alone.
These common SMSF investment breaches will make this a little clearer:
- Your SMSF cannot loan money to a friend or family member on an interest free basis. The loan must be repaid with interest set at current market rates.
- You cannot lease a business premises owned by the SMSF for lower than the market rate of rent.
- Your SMSF cannot invest in a related unit trust which doesn’t pay distributions to the fund even though they are due.
- Your SMSF cannot sell a property it owns to a family member for less than the market value.
So What Can And Should Your SMSF Invest In?
Technically, your SMSF can invest in many things as long as it complies with the rules mentioned previously. Here are some prime examples of good SMSF investments:
- Shares – Your SMSF can certainly invest in shares but unless you know a lot about share trading you should probably get some good advice from a professional as to the type of shares that your SMSF should purchase.
- Term Deposits, Income Securities & Bonds – These are generally a good safe investment and are guaranteed to provide a positive return.
- Gold & Silver Bullion – Another good safe investment that is pretty sure to give your fund a positive return.
- Residential Investment Properties – Any type of residential property can supply your fund with a rental income as well as a good return when the fund sells the property as long as it has built up some substantial equity. Obviously you need to make sure that the property is positively geared so that it does produce an income for the fund.
- Commercial Property – Commercial property is also great as it will produce an income for the fund in the form of rent and of course capital growth.
- Collectibles – Your SMSF can also invest in collectibles such as artwork, jewellery, antiques, coins, stamps and wine. Please note though that there are very strict rules governing the purchasing and holding of collectibles within your SMSF.
For example, no member of the fund can gain any kind of enjoyment from these assets while they are owned by the fund. Artwork cannot be hung in a members home, neither can jewellery be worn or antiques used by any member of the fund or their relatives.
You can however, rent the artworks or other items out commercially so that the fund receives a rental income from them.
What Are Some Of The Benefits Of Your SMSF Owning An Investment Property?
Investing some of your SMSF money in investment property can have a number of advantages especially when it comes to tax. These include:
- Any rental income paid to the fund minus any tax-deductible expenses is taxed at a flat rate of 15% whereas tax on personal rental income paid to a private owner can be as high as 46.5%.
- There are also savings in relation to capital gains tax. If an SMSF has held a property for more than 12 months, then capital gains tax is charged at a flat rate of 10%. On the other hand, an individual private owner is likely to be charged around 23.25% or even more depending on the circumstances.
- Once a member of the SMSF is eligible to draw a regular income stream from the fund, the rental income and capital gains on any property owned by the fund is tax free.
As you can see, there are plenty of options for investing your SMSF funds. The important thing to remember is to make sure that all your investments follow the SMSF guidelines and don’t contravene any of the rules.
It’s also really important to ensure that you have a good investment strategy and that your SMSF diversifies its investments so that you minimise any possible risk of losing money on your investments.