Self managed super funds are about to enter a revolution. New rules have legitimised a form of borrowing in superannuation – something generally not allowed in super funds.

The new rules will allow a superannuation fund to invest in instalment warrants backed by a much wider range of assets than at present. Instalment warrants are offered by financial institutions as a way to buy shares ‘on lay-by’. As an example, the warrant may allow an investor to buy a share worth $10 in two instalments. The investor will pay $6 now and $5 in 12 months time. The institution will lend the investor the $5 and $1 goes towards interest and expenses. The investor receives all dividends and franking credits.

In 12 months time, the investor can pay the $5 and have ownership of the share outright. They are not forced to pay the $5 but if they decide not to pay it, the shares are forfeited. The loan is called a ‘non recourse’ loan because the institution cannot seek repayment of the loan from the other assets of the investor.

The new rules are based on an instalment warrant but can be used to purchase any asset a superannuation fund could normally invest in including commercial property, residential property, artwork, collectables as well as shares and managed funds.

Investing this way has many advantages for a superannuation fund.

Improved diversification

The fund can buy more assets with the cash available enabling a wider spread of investments.

Increased scale

The fund can buy bigger assets (such as property) that it may not otherwise have been able to afford.

Increased income

The fund will receive all the income from the investments – dividends, rent and distributions – despite not fully owning the asset.

Improved tax effectiveness

The fund will receive franking credits on dividends from shares, depreciation allowances on rental income and can claim a tax deduction for the interest on the loan.

Improved capital gains

Borrowing to invest increases the gains when the asset appreciates in value (though, of course, it also magnifies the loss when asset values fall).

Self managed super funds provide greater investment flexibility than other funds. These new rules will give superannuation funds the best of all worlds – a concessionally taxed structure where assets are protected from creditors and a structured form of borrowing providing all the benefits of gearing.

The new rules are very specific about how the instalment warrant must be structured. This is an area where it is vital you get good advice.