LRBAs – fact or fiction

Those two old hoary chestnuts – LRBAs are a systematic risk to the superannuation system and are crowding young buyers out the housing market – are doing the rounds again, this time sparked by the vigorous debate about the proposed new tax on super balances above $3 million.

We make no apology for strongly opposing this new tax. We believe it’s unnecessary and is bad public policy – and have said so long and hard. In particular, the proposal to tax unrealised capital gains could have dire financial consequences for some SMSFs, especially in the farming and small business sectors as well as venture capital.

But even we could not believe that this issue would prompt a fresh debate about LRBAs. Yet here we are again.

It’s our firm belief that LRBAs are again being used as a stalking horse for those who find the concept of people taking control of their own retirement savings via an SMSF an anathema. They believe superannuation is too complex, too risky, for it to be left with individuals. The fact that the data conclusively shows, in terms of costs or investment returns, that SMSFs are a viable superannuation option for those who choose it is conveniently ignored.

Once again, critics have hung their hat on the Financial System Inquiry (FSI) report that was handed down in December 2014 recommending that LRBAs be abolished – a recommendation the Government chose to ignore.

That’s nearly a decade ago! Since then, we have had significant changes to the advice sector, a Royal Commission and a number of reforms that have substantially reshaped financial advice as a profession.

Two Council of Financial Regulators reports (2019 and 2022) have also since examined the evidence and unambiguously concluded LRBAs are not a threat to the system. It is worth quoting the 2022 report in full. “This report and the previous 2019 report on leverage and risk in the superannuation system establish a clear baseline for monitoring risks relating to LRBAs in the superannuation system. They demonstrate that borrowing by SMSFs through LRBAs has not (my emphasis) posed a material risk to the superannuation system or broader financial system since it was first permitted in 2007.”

The report does add there is evidence LRBAs are used in inappropriate ways by some individuals and can be a high risk to their retirement savings and, by extension, increase the risk of higher fiscal outlays through the Age Pension.

So, there you have it. Some individuals (and promoters) misuse LRBAs (the number is never specified) so therefore the obvious solution, indeed, the only solution, is to ban LRBAs. Such a “solution” is totally erroneous.

Before explaining why, let me be clear on one thing. No organisation (with member support) has taken a stronger stance against the misuse of LRBAs. We have urged the regulators to be vigilant against unlicensed advice and dodgy property spruikers who encourage investors to set up an SMSF to purchase property through an LRBA. We have always recommended that anyone considering using an LRBA get specialist professional advice. They are a complex debt instrument requiring expert input.

So, what benefits do LRBAs offer? Around 42 per cent of assets held under an LRBA borrowings are non-residential real property (ATO figures), helping small businesses and farms be more financially viable and helping secure their owners’ financial security in retirement.

Like any debt instrument used sensibly (the maximum LVR for an LRBA from a specialist lender is normally around 80 per cent), they enhance people’s personal wealth. It’s not a long bow to draw to say many now in retirement are more financially secure because they used leverage – no different to the millions of Australians who borrow to buy their house.

Allegations that LRBAs are on an exponential growth path are simply wrong. A common mistake is to take the value of total assets held in an LRBA arrangement as the total value of LRBA debt. And yes, asset values have increased over time, as we would expect. So let’s look at the numbers!

At 30 June 2022, the value of SMSF borrowings were $22.6 billion, having peaked at $25.2 billion in 2019-20. Over the same period, the total value of assets (property and other investments) subject to an LRBA were $56.3 billion and $52.91 billion respectively.

Although over the past 10 years there has been an upward trend of SMSFs adopting LRBAs, the proportion of SMSFs using LRBAs is showing signs of stabilizing or slightly decreasing in recent years. Only 11% of SMSFs have an LRBA and LRBA borrowings represent just 2.7% of total assets for the sector.

On squeezing out first home buyers, well, based on the ATO’s annual statistics for 2021-22, SMSF investment in residential property, both directly and through LRBAs, stood at $76.9 billion. With CoreLogic valuing Australia’s residential market at $10.8 trillion, it means SMSFs hold about 0.7 per cent of the market. I’m no economist, but I fail to see how such a low level of investment is crowding out first home buyers.

As a recent Reserve Bank research paper cogently argued, the housing crisis is fundamentally an issue of supply, explaining in some detail why it has failed to keep up with demand. LRBAs did not rate a mention.

Since LRBAs become an investment tool in 2007, they have been mired in controversy, a convenient whipping boy for those with an axe to grind against SMSFs. Everyone is entitled to their opinion. I only wish they would base their arguments on fact, not fiction.

Written by Peter Burgess, 
CEO, SMSF Association