THE POTENTIAL OF INTERGENERATIONAL FINANCIAL PLANNING
IFP treats an extended family as one large client and so aims to implement strategies that are beneficial across generations.
It is less important who owns the investment. The idea is to maximize the after tax returns to the family. Investment time horizons can be measured in decades, even generations, rather than years.
Trusts, companies and SMSFs each have a role to play, as does the careful creation of deductible debt, in the right place and at the right time.
As the name suggests, IFP is where the adviser thinks beyond the immediate needs of the client sitting in front of him or her, and instead extends the thinking ‘upwards’ to older members and ‘downwards’ to younger members of the client’s family.
All Clients Are Likely Candidates for IFP
Advisers who are prepared to spend a little extra time with all new clients will find out a bit more about the person, their life views and their relationships with friends and family. Often the extra time reveals important facts, hopes and attitudes you can then blend into their advice and strategies, making them better than ever.
Often a glimpse reveals a client supporting elderly parents or young (and sometimes not so young) adult children – and sometimes both. This immediately raises the question of whether these responsibilities can be incorporated into the client’s overall financial plan. It frequently can.
We came across some interesting research recently which has very much focussed our mind on the importance of inter-generational financial planning. The research was conducted by the Grattan Institute and released in December 2014.
It shows that a person’s prospects of receiving an inheritance peak in that person’s 50s and 60s. This would seem to reflect the fact that most people inherit from their parents, which is happening quite late in the inheritors’ life as their parents live into their 80s and 90s. (We expect that the more than 5% of inheritors who receive inheritances in their 80s receive them from age-peers such as siblings, or even adult children, rather than parents).
By the time inheritors have reached their 50s or 60s, the impact on their own lives of a substantial inheritance is lower than it would have been had that assistance been available earlier. By the 50s and especially the 60s, most people have completed the most expensive years of their lives – the child-rearing years. The inheritance might make for a nicer retirement, but you cannot help but wonder: how much more utility would the family as a whole have had if the recently-inherited wealth had been shared out among the rest of the family sooner?
This is where IFP really comes into its own. It assists with the transfer of wealth between generations so that the maximum utility for the family as a whole is achieved.
The Importance of Strategies in Effective IFP
Perhaps more than in any other area of financial planning, effective IFP requires a commitment to creativity in the development of strategies for clients. Examples of effective strategies that can be used include:
Strategies for Clients with Low-to-Average Wealth
Retired Mum Helping Single-Parent Daughter
Margaret is a widowed client in her late 60s. She owns her own home worth $650,000 and has $300,000 in a SMSF. She is naturally cautious and withdraws $2,000 per month from her conservatively invested fund. Other than this she lives on the old aged pension.
Margaret’s daughter Kylie is doing things very tough. She is a single mum aged 45 with three school-aged children. She received the home – and a $250,000 debt – in the divorce and her ex-husband does not pay child support. She earns $60,000 salary and receives some family tax benefit on top of that.
Margaret would love to simply pay off Kylie’s home loan but worries that this will leave her (Margaret) too vulnerable as she enters old age.
One idea involves Kylie converting the loan be “interest only” which Margaret services. This allows Kylie to increase her deductible super contributions and accrue savings in a very tax effective environment. The loan principal can be retired when Kylie eventually retires after reaching age 60. She has been able to do this because she has effectively received a small part of her inheritance when she needed it most. That is what IFP can achieve.
Strategies for Older Clients with Above-Average Wealth
Higher Wealth Parents – A Home for Every Child
Add to that the increasing unaffordability of housing, and many older people worry that they will never live within a reasonable distance of their grandchildren. Alternatively, they may worry that their adult children will never be able to afford to move out.
The entry price into most popular suburbs in major cities is often too high for most people under age 40 – even those in well-paid employment. Frequently, a new home is only afforded with a bit of discrete help from Grandma and Grandpa. It’s just not possible otherwise, particular if there are kids in the kitchen or buns in the oven.
What will housing prices be like in two decades time? Who knows?
How will your clients’ children afford to pay these prices? Who knows?
One idea to explore if a client can afford to ‘buy’ their child a home now. It does not have to be something the child will actually live in when they are 50. But it should be in a major city and have good growth prospects.
Clients should not necessarily actually give the child the home. But they should consider bringing a ‘home for every child’ into the family now. Doing this in effect insulates the family against future home price increases and protects the next generation against the risk of runaway home prices.
The tax maths show that a relatively small after tax cost to Mum and Dad in the early years spares the child a large before tax cost in the later years. This sparing gives the child a real economic head start in life and, with a bit of luck, the child’s own efforts will amplify this head start many times over. The bottom line is that it can be almost cash-flow neutral to fully gear a rental property if the interest rate is 5% and the rental yield is 3%.
Perhaps the homes are owned through a family trust and the children just live in them later on while saving for their own homes and investments. This has the added advantage of protecting those children against the risk of losing assets in divorce. Remember, the divorce rate is more than 50% for young marriages.Get Advice