Since 1 July 2017 once a member’s superannuation balance reaches $1.6 million they are unable to make any further Non-Concessional Contributions.
Furthermore, the bring forward provisions are not available for any member whose superannuation balance is more than $1.5 million and only a restricted bring forward amount will be available for members whose superannuation balance is greater than $1.4 million.
This presents a couple of potentially major issues for members with larger superannuation balances where the bulk of their Superannuation Investments are large properties or other large and illiquid assets. A couple of issues include the funding of any LRBA repayments and the funding of minimum pensions as members get older.
Funding Loan Repayments
If an LRBA exists on one or more of the properties requiring regular interest and principal repayments, the cap on being able to contribute creates a significant headache for funds in ensuring they continue to meet all loan repayments and pay down the loan.
Consider the following facts:
- A large fund where two members each have a balance of $4 million owns two large commercial properties worth $10 million each (7% yield after holding costs).
- Borrowings of $6 million to related entities in the group exist on each property (both loans met safe harbour conditions).
Previous to the introduction of both the Safe Harbour provisions for related party borrowings and the new limit on being able to make non concessional contributions, a fund in this position may have paid a nominal interest amount on an interest only loan and utilised Non Concessional contributions to pay down the loan over time.
Under the new rules they will not be able to do so. Whilst funding loan repayments when both properties are tenanted in this example would not pose too much of a problem, if either of the two properties was to be vacant for a period of time, meeting the minimum loan repayments on the borrowings will pose a significant challenge. This problem gets magnified where the fund is also in pension phase and required to make minimum annual pension payments.
Funding Pension Payments
Where the fund is in Retirement Phase it is required to pay out 4%-9% of each members opening pension balance as an annual pension. Where the investments do not return enough cash profits to meet these requirements a cash buffer or cash injection will be required. Members who satisfied the work test have previously been able to make contributions to their SMSF to fund these pension requirements. With the restrictions on making non concessional contributions a fund may find that it has insufficient liquidity to make the required pension payments especially if the fund has borrowed the majority of the proceeds to acquire the property.
As discussed above at this issue is multiplied where there is also borrowings within the fund on property held.
If we use the facts of example 1 above and add that both members are in pension phase.
Calculating the Net Cash return on the properties we get the following figures:
|Net Rental Income Received||$1,400,000|
|Interest Cost on Borrowings||$676,455|
|Total pre-tax profit on properties||$723,545|
|Tax on earnings (3.2M/8M x profit)= tax free||$65,120|
|Total principal loan repayments required (15 year term)||$519,335|
|Net cash flow generated by property||$139,090|
This fund therefore generates only $139,090 worth of after tax profits with which to fund the member’s minimum pension requirements. If both members were 65 their pension minimum would be 5% of $1.6 Million each equating to $160,000. This fund would be unable to meet both its pension and loan obligations out of its investment income. Without a cash reserve, the fund would need to divest of one of these assets in order to meet both of these obligations’.
The information above is provided as an information service only and, therefore, does not constitute financial product advice, and should not be relied upon as financial product advice. None of the information provided takes into account your personal objectives, financial situation or needs. You must determine whether the information is appropriate in terms of your particular circumstances. For financial product advice that takes into account of your particular objectives, financial situation or needs, you should consider seeking financial advice from an Australian Financial Services licensee before making a financial decision.