Action needed on Division 7A loans

Division 7A loans SMSFs

Despite changes to Division 7A loans not starting until mid-2020, SMSFs should aim to pay them off rather than be saddled with a more restrictive regime.

Financial advisers should be working with clients who have to reduce the levels of Division 7A loans as pending changes may not enable trustees of SMSFs to clear the debt in retirement, according to a tax and superannuation expert.

Chartered Accountants Australia and New Zealand (CAANZ) senior tax and superannuation trainer James McPhedran described the changes, which were first proposed in October 2018 and deferred to 1 July 2020, as an issue advisers should be addressing in the present if they have not already begun to do so.

“If you have clients with Division 7A loans, get on to them because the coming changes are nasty and will require them to pay more interest on higher principal sums, and in some cases for longer periods,” McPhedran said at the recent CAANZ National SMSF Conference in Sydney.

Specifically, the pending changes will result in the benchmark interest rate for Division 7A loans rising by 3 per cent and 10-year complying loan terms replacing seven-year and 25-year loan terms. Pre-1997 loans will also have to be paid over 10 years using the new benchmark interest rate and trust unpaid present entitlements to private companies will be deemed loans.

“If you are not onto this, you should be because Division 7A loans are about to get a whole lot worse and as rates go up, the calculation of the interest on the principal will go up, which means more interest on more principal for longer,” he added referring to seven-year loans being extended to the new 10-year loan period.

“You clients should start looking at these changes because they shouldn’t take large balances into the new Division 7A framework.

“You also don’t want to see clients passing away owing huge amounts of money because that could be a claim against the estate, or if the loan is not with an individual, it could be against the trading entity and there could be problems getting the money out into the entity that is owed the money.”

He said advisers he spoke with were active in speaking with clients about their SMSFs and their balances, but they should ask clients if they had Division 7A loans and if they did, encourage them to start paying it off and putting the money into the bucket company and treating that as a second retirement vehicle.

“A Division 7A position for a client can be managed, but it is much better to do that now when the business related to the loan is running and profitable,” he said.

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