There’s a lot said, written and discussed about superannuation. I know it’s generally not a popular topic amongst business people and farmers in particular. The main objection is that they can’t use their superannuation savings in their business. While it might be a wonderful off-farm asset to have, running a business like farming needs lots of capital so superannuation actually diverts capital away from where it’s needed. The other common concern is that you can’t access your retirement savings until you are 60 and retired (there are transition rules around this age). These are valid objections if you only understand superannuation from what we hear in the media. I think this is why it hasn’t been accepted by the rural community as an ideal way to invest.
Superannuation is not an investment
The greatest misconception about superannuation is that people believe it’s an investment. It isn’t. It is a tax special tax structure with a raft of taxation and compliance laws. How you invest your superannuation is largely the decision of the super fund member. That means there’s more freedom and control of how your savings are invested than you might think. Generally, the vast majority of super fund investors leave this important decision to industry and retail fund managers. This is a bit like buying a new home and leaving to the builder to decide what’s best for you.
Superannuation and your farm business
I want to discuss the principle of investment choice a little further and relate that back to operating a business. One of the most cost and tax effective ways to employ your superannuation savings is in purchasing assets such as farm land or commercial property. This is where huge amounts of capital can be soaked up especially if borrowing is involved. When you include the interest costs and additional tax involved, it becomes a very significant amount of money. One of the great benefits of this strategy is that you are the manager of your superannuation and you make the investment selection. Even better, you’ll be farming the land owned by your superannuation fund. I can’t think of a better tenant than yourself. The objection of not being able to use your retirement savings until retirement now goes out the window.
You can buy farm land with Superannuation
I feel the story even gets better. When you operate your own super fund (known as a self managed super fund) you have the unique ability to borrow to purchase farm land or commercial property. As a rule of thumb, a lender will lend dollar for dollar.
One of the most powerful benefits of the borrowing strategy is the tax effective way of repaying the loan. While interest costs are tax deductible, principle payments are fully taxable. We find this is often over looked and can be a problem when large capital re-payments are made. Even worse, it will affect your 5 year averaging. Superannuation is far more cost effective because of the flat 15% tax rate as opposed to personal or company tax rates which are generally twice as much or more than super. In a transaction involving significant amount of borrowing, the savings can be many hundreds of thousands of dollars.
I know this might sound too good to be true. And yes, there’s much more you should know and understand before going down this path. It is paramount that you get sound financial and tax advice around this strategy so you can make an informed decision if this is right for you. I do know that for those farmers we’ve assisted, they are grateful for the advice, support and savings.
In other articles I’ve written about buying land through superannuation, the focus has been on the huge savings in tax. While this is a motivating factor and good reason to use this strategy, it’s not the only major advantage.
There’s an old adage that says ‘only buy investments you understand.’ For a farmer who is looking to buy land this makes perfect sense. Why? Because they get to choose their investment and act as their own investment manager.
Farm land is an asset they know, trust and understand. In addition, they get to use the land in their business. When you combine this with the significant tax advantages of superannuation, it’s a win win outcome. There’s no doubt that making investment decisions like this gives greater confidence, meaning and peace of mind.
Because of the generally large outlay in purchasing farm land, invariably most will go down the path of borrowing. Most times the decision to buy more land is not something that is planned because land is quite tightly held and opportunities only present from time to time.
Farming is capital intensive so I don’t know too many farmers who have a stash put away waiting to buy their neighbour’s property.
The most common way that farm land is bought is to arrange a loan with a bank and hopefully pay the debt over a number of years. The great thing about farming is that it’s truly a long term business and assets like farm land usually stay in the family for the next generation to benefit from.
The disadvantage of buying land this way is that it is very expensive; not because of the interest rate but because of the tax that will be paid in repaying the loan principle.
Superannuation on the other hand is a far more cost effective strategy especially where borrowing is used. The savings and advantages are just too great to not consider this option.
In a like for like situation with similar borrowing arrangements, the savings through superannuation are many hundreds of thousands of dollars less compared to traditional borrowings (assuming the purchase price is around $1m). Not only are there huge savings but the time to payout the loan is years less.
There are in essence two main methods of financing farm land through superannuation. The loan structures and arrangements are quite different so it’s a matter of matching your objectives and circumstances to the strategy that will give you the optimum results.
Because of the strict compliance and legal requirements around superannuation it’s advisable to seek professional advice and support from a specialist financial adviser and accountant who have skills in this area.
When buying investment property the most valuable benefit of the superannuation and gearing strategy is the tax effectiveness of repaying the loan.
Very simply, repayment of any loan principle is not a tax deductible expense (interest, depreciation and associated costs are). This means that any principle payments must be made with after tax dollars. Under the non-superannuation principle you would need to gross up your income to allow for your marginal tax rate, pay the tax to net the income and then repay the loan.
So, for someone who has a taxable income between $37,000 and $80,000 their marginal tax rate is 34%. This means that to repay $1,000 off the principle they would need to gross $1,515. The outcome is worse for those on higher marginal tax rates. Superannuation, on the other hand, is taxed at a universal rate of 15% so there is less gross income needed to repay the same loan. For the same $1,000 of principle payment, the gross income needed is $1,176 which equates to very significant savings.
In August we headed over to the Eyre Peninsula to be part of EPIC’s grain marketing expo. The expo is held every second year and features a range of grain marketing firms in the one room to present to local growers. We were invited to speak on a different topic of interest – Buying rural land the smart way. This was ideal, given the work we do with farmers on the Yorke and Eyre Peninsulas.
Essentially, the presentation outlined the benefits of purchasing land using a Self Managed Super Fund. Although it’s not a solution for everyone, it can be very powerful estate planning and tax minimisation tool when multiple generations are involved on the one farm. Above all, it helps do two things: grow the farm and make the ‘parents’ more self-sufficient when it comes to retirement.
To see a copy of the presentation, please Click here.
If you would like to know more about this, please feel free to contact us.
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