How to borrow to invest and potentially boost your retirement savings
When it comes to your retirement savings, more is always better. While everyone’s circumstances are different, you’ll need about two-thirds of your pre-retirement income to maintain the same standard of living after you stop work.
The good news is there are steps you can take now to close your savings gap. One way is to borrow to invest, to try to accelerate your wealth.
Borrowing to invest, also known as gearing, does involve a number of risks, so it’s important to understand these as well as the potential benefits when deciding if this strategy is right for you.
If you have a self-managed super fund (SMSF), a trustee can use a limited recourse borrowing arrangement to purchase an investment, including shares and property.
The investment is held in a separate trust, and the investment returns from the property go to the SMSF trustee. Importantly, the lender’s rights are limited to the asset in the separate trust, which means the lender has no recourse to the rest of the assets in the SMSF.
Loan repayments must be made from your SMSF so you need to ensure you’ll have sufficient funds to meet these.
An example of how this strategy can be used to top up retirement savings is your SMSF could purchase your business premises, while you pay rent directly to your SMSF at the market rate. There are a number or rules to be aware of before you implement this strategy, and it’s important to talk to an adviser first.
You have more money available to invest: You can buy more assets than you could if you were just using your own money, which can help to increase your returns and accelerate your wealth.
It may be tax effective:Usually, the interest payments on a loan outside of super are tax deductible to the extent that the loan amount is used to acquire income-producing assets. In these circumstances, borrowing to invest may give you some tax advantages.
You may not earn as much on your investment as you had expected or hoped to
Your investment may drop in value and the proceeds from the sale may not cover the remaining loan balance
Interest rates on the loan may rise – making loan repayments higher
You income may reduce or cease due to illness, injury or redundancy
As a general rule, your after-tax investment return should be higher than the cost of the loan (including fees and interest). If it’s not, you may be taking on more risk than you need to for a low return.
Make sure you have reliable income from other sources in case you receive a margin call, or interest rates change. It’s also important not to invest simply because of the tax deduction alone.
While there can be benefits in gearing, it’s essential to understand the potential risks. So it makes sense to speak with your financial adviser and/or registered tax agent before you borrow, to help you decide if it’s the right strategy for you.
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