Lending Money from your SMSF
When self-managed super fund (SMSF) trustees choose to loan money, careful consideration must be given to ensure compliance with superannuation laws and to protect the fund’s assets. Loaning money can be a valuable strategy for growing the fund’s wealth, but it involves a series of critical decision-making steps to maintain the integrity and primary objectives of the SMSF. Here are the essential factors trustees should evaluate:
1. Interest Frequency and Type
Deciding how often interest is paid (monthly, quarterly, or annually) is crucial for cash flow planning within the SMSF. Trustees must also determine whether the interest will be capitalised or paid regularly. Capitalised interest is added to the principal amount of the loan and is compounded over time, whereas paid interest is periodically cleared and does not increase the principal.
2. Written Agreement
A formal, written loan agreement is mandatory. This document should outline all terms and conditions of the loan, including the loan amount, interest rate, repayment schedule, and what happens in case of a default. This agreement serves as a legal record and helps avoid disputes by clearly stating the expectations and obligations of all parties involved.
3. Repayment Date
Setting a clear repayment date is crucial. This date should be realistic and reflect the borrower’s ability to repay within that timeframe. It should also align with the cash flow requirements and investment objectives of the SMSF.
4. Interest Rate: Fixed or Floating
Trustees need to decide between a fixed or floating interest rate. A fixed-rate provides certainty over the repayments throughout the term of the loan, which can aid in stable financial planning. Conversely, a floating rate, often linked to an external benchmark like the official cash rate, can fluctuate, potentially offering lower rates dependent on market conditions but also introducing variability and risk.
5. Compliance with the Sole Purpose Test
Every decision an SMSF trustee makes, including loaning funds, must comply with the sole purpose test. This test ensures that the fund is maintained for the sole purpose of providing retirement benefits to its members, or to their dependants if a member dies before retirement. Loaning money to a party that does not meet this criterion, or under terms that do not favor the SMSF’s financial growth, could be seen as a breach.
6. Alignment with the SMSF’s Investment Strategy
The investment strategy of an SMSF outlines how the trustees plan to achieve the fund’s financial objectives. Any loan given by the SMSF must align with this strategy, considering the risk, diversification, liquidity, and the ability of the fund to meet its financial obligations. Before making a loan, trustees should reassess their strategy to ensure the loan fits within these parameters and adjust the strategy if necessary to include the loan as a part of the fund’s broader investment goals.
Conclusion
Loaning money as an SMSF trustee involves a myriad of considerations that can significantly impact the fund’s performance and compliance. By meticulously planning and documenting each aspect of the loan, from the interest terms to the compliance with the sole purpose test, trustees can safeguard their members’ retirement benefits while engaging in what can be a fruitful investment avenue. Always consider consulting with a professional SMSF advisor to ensure that all legal and regulatory requirements are met, protecting both the trustees and the beneficiaries of the fund.