The landscape of Self-Managed Superannuation Funds (SMSFs) has been significantly influenced by recent interest rate hikes, with trustees facing challenges and opportunities alike. As SMSF trustees grapple with the implications of higher interest rates on limited recourse borrowing arrangements (LRBAs) and investment strategies, it’s essential to understand the changing dynamics and make informed decisions. In this blog, we’ll explore how rising interest rates affect SMSFs, particularly concerning LRBA and investment choices.
The Impact of Rising Interest Rates on SMSFs
- LRBAs and Safe Harbour Terms:
Trustees who have utilised limited recourse borrowing arrangements are now encountering the collective effect of ten interest rate increases since May 2022. From July 2023, SMSF trustees relying on the Australian Taxation Office’s (ATO) safe harbour terms are facing higher monthly repayments for both interest and principal.
- Safe Harbour Interest Rate for 2023/24:
The Safe Harbour annual interest rate for 2023/24, as determined by the ATO, is linked to the Reserve Bank of Australia’s Indicator Lending Rate for investors’ standard variable housing loans. For SMSFs with a related-party LRBA financing real property purchases, the relevant interest rate for 2023/24 increases to 8.85%. This represents a significant increase of 3.5% from the previous rate of 5.35%.
- Impact on Investments:
The repercussions of higher interest rates are leading super funds to shift their investment strategies. Cash and low-risk assets are becoming more attractive to manage risk, particularly as term deposits and bonds provide stability. A report shows that funds have increased their exposure to cash products from 18% to 22% of their savings pools over the past year.
– Equity Exposure Decrease: As SMSFs divert funds from the share market to less volatile assets, the direct investment exposure to the share market has dropped by 5%.
– Investment Strategy Consistency: It’s essential to remember that any shift in investment strategy should align with the overall SMSF investment strategy. Trustees should assess whether such changes are in the best interests of all members, including those with a preference for bolder investment strategies.
Managing the Impact: Practical Steps for SMSF Trustees
- Cash Flow Management:
With higher interest rates influencing monthly repayments, managing cash flow becomes paramount. Trustees should collaborate with their SMSF advisors to explore strategies for maximising cash flow, potentially including additional contributions to the fund when possible.
- Review Investment Strategy:
Trustees should review their SMSF’s investment strategy to ensure its alignment with the changing economic environment. This review should consider the risk tolerance, financial goals, and preferences of all members.
- Balancing Risk and Returns:
While shifting towards lower-risk investments can provide stability, it’s crucial to maintain a balance between risk and potential returns. Diversification remains a fundamental principle in managing SMSF investments effectively.
The confluence of rising interest rates and changing investment dynamics has brought about a significant shift in the SMSF landscape. Trustees must carefully consider the impact on their limited recourse borrowing arrangements and investment strategies. While seeking low-risk assets like cash and bonds can provide stability, it’s vital to ensure that any process changes are consistent with the SMSF’s overall objectives and members’ circumstances. Consulting with SMSF advisors and financial experts will be instrumental in making well-informed decisions that navigate the challenges and capitalise on the opportunities presented by higher interest rates.