Self-Managed Super Funds (SMSFs) come with a level of flexibility and control that many find appealing, but they also come with stringent rules. One area of common misunderstanding -and potential breaches – is lending from your SMSF. Recently, Audit Your Superfund has seen cases where SMSF trustees have loaned money to family members, a practice strictly prohibited by the rules. This article provides a refresher on what’s permitted, who you can lend to, and why commercial terms are critical.
Understanding SMSF lending rules
Lending from an SMSF can often look like a straightforward process, but there are crucial guidelines on who the loan can be extended to and the purpose behind it.
1. No loans to members or close relatives
Under no circumstances can an SMSF lend money to its members or their close relatives. Even if the loan is made with the best intentions – perhaps to help a family member’s business – or it’s structured on commercial terms, it’s still not allowed. The rule applies across the board, whether it’s a direct loan or indirect “financial assistance.” For instance, an SMSF cannot lend money to a friend who intends to re-lend it to a member or a relative of the member.
2. Loans to related parties are limited
While loans to SMSF members or their close relatives are prohibited, lending to certain “related parties” is permissible under limited circumstances. A related party may include entities, such as trusts or companies, closely connected to the members. For instance, a family trust or business entity that a member controls can receive loans from the SMSF.
However, such loans are considered “in-house assets,” which are capped at 5% of the SMSF’s total asset value. So, if an SMSF wants to lend $80,000 to a family trust, the fund’s total value must exceed $1.6 million to remain within the 5% in-house asset limit. Any breach of this limit can result in significant compliance issues and penalties.
3. Maintaining commercial terms
For any loan made by an SMSF – whether to a related party within the 5% limit or an unrelated third party – it is essential to ensure the loan is structured on commercial terms. This means that the following are necessary:
- Formal documentation: The loan arrangement should be in writing, specifying the loan amount, repayment schedule, and interest rate.
- Commercial interest rates: The interest rate charged should reflect what a bank or other lender would charge for a similar loan.
- Appropriate security: Consider asking for guarantees or collateral – just as a bank would require – if the loan is unsecured.
- Enforcement of terms: If a borrower defaults, the SMSF trustee must take steps to enforce the agreement, just as a bank would, to protect the fund’s assets.
4. Meeting the sole purpose test
Every SMSF must adhere to the “sole purpose test,” which means any investment – including loans – should have the primary objective of providing retirement benefits to its members. A loan made with other motivations, such as propping up a struggling business, would violate this rule and place the SMSF in jeopardy of non-compliance.
A compliant alternative: Drawing a lump sum for loans
If an SMSF member is looking to support a family member or a related entity financially, one option is to take a lump sum or partial withdrawal from the SMSF (if eligible) and then enter into a separate loan arrangement. This approach keeps the SMSF’s lending within compliance while allowing you to assist family members or invest in a business. Keep in mind that any withdrawals should be carefully considered to ensure they align with your retirement goals and meet the SMSF’s compliance obligations.
Key takeaways
While SMSFs can lend money as part of an investment strategy, doing so requires strict adherence to the rules:
- No direct loans to members or their close relatives under any circumstances
- Loans to related parties are permitted, but you must be clear on the definition of a ‘related party’ and stay within the 5% in-house asset cap
- All loans should be structured on commercial terms and for the sole purpose of retirement savings.
Loans from an SMSF can provide strategic investment opportunities, but only if executed correctly and within legal boundaries.
If you’re unsure about your SMSF lending arrangements, please contact Audit Your Superfund.