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The rise of the bank of mum and dad and how to avoid the pitfalls

Michael Blake
Monday, April 30, 2018

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By Michael Blake, Head of Centuria Life

According to the Oxford Dictionary, the “Bank of Mum and Dad” is defined as a situation where “a person’s parents are regarded as a source of financial assistance or support, especially in the context of the purchase of property”. And according to Australian financial comparison website Mozo, this new ‘bank’ is the country’s fifth largest lender, right behind the big four. Collectively, these ‘bankers’ have lent approximately $65.3 billion to their offspring, usually in one of two ways:

  • By allowing children to live rent (and bill) free at home while they save for a deposit or start a business; and
  • By providing upfront cash support for a deposit and/or repayments.

In fact, Mozo concluded that 29% of parents – or more than one million families – assist their children in buying a home. And this fact is backed up by findings from a survey commissioned by National Seniors Australia and investment manager Challenger in June 2017 which found that only 10% of retirees intend to spend all their savings on themselves, but rather expect to have to help children buy their own home during their lifetime.

And children are expecting more as well. Another recent report commissioned by Legal & General and the Centre for Economics & Business Research in the UK found that the proportion of prospective buyers who expect to get help from family has risen by 30% in one year. Now nearly half (48%) of first-time buyers expect to get some help from their parents.

This is good news for the children, but what about the parents? Unlike traditional bankers, over two thirds (67%) don’t expect to be repaid – so what does this mean for their retirement? 

Are they negatively affecting the quality of their own retirement by dipping into savings? The same survey from National Seniors Australia suggested that they might well be. It found that becoming the Bank of Mum and Dad increased the risk of reduced savings as well as financial hardship later in life.

In a nutshell

So what exactly is behind the rise of the bank of mum and dad? Why has it become so prevalent, what are the consequences and most importantly, what are the likely impacts on mum and dad themselves? 

Put simply, housing affordability.

  • A shortage of stock, low interest rates and the relaxation of foreign ownership laws have driven up prices and pushed young people out of the market. 
  • Most banks require a deposit of a minimum of 20%, which in the case of Melbourne equates to around $173,000 for a median priced house, and $250,000 in Sydney.
  • According to a report published by RMIT and Curtin University for the Australian House and Urban Research Institute (AHURI) the way the baby boomer cohort choose to pass on housing wealth to the children will have an increasingly important influence on the welfare of generations X and Y.
  • Results suggest that 25-45 year olds who receive a cash gift from parents have home ownership rates which are 15% higher than their peers, lifting the proportion who owned a home from 45-60%.

Impacts on mum and dad

  • According to Mozo’s research, two-thirds of families providing financial assistance do so from their savings. Nine per cent delay their retirement to help their children. Other reports show parents drawing down on their own mortgage to fund those of their children
  • Sometimes mum and dad can ill afford to help their children. Despite the fact that super assets are at an all-time high, $2.5 trillion at 30 September 2017, many Australians still do not have sufficient super to be self-sufficient in retirement.
  • The net result is twofold, either parents defer retirement to continue supporting children, or they retire with reduced savings and/or an ongoing mortgage to service.

Finding a better way

For parents who don’t have the means to help children without dipping into their own savings or delaying retirement, the best way to help their children is, of course, to plan ahead and save, or to encourage children to do so.

This is easier said than done. And if you are paying the highest tax rate, saving can feel like one step forward and two back, if every dollar you make becomes 50cents when the tax man calls. And as for children saving, more often than not they are not in a position to contribute to a savings plan until they are working.

And there are additional challenges in deciding just how to save. Using a savings account or term deposit is a common option, but the rates of return are so low that on an after-tax basis returns keep pace with inflation. 

Investment bonds.

One option which provides serious tax advantage, with flexibility and low cost is an investment bond. 

An investment bond is actually an insurance policy, with a life insured and a beneficiary, but in reality it operates like a tax-paid managed fund. And as with a managed fund, there are a number of underlying portfolios to choose from. 

These typically range from growth oriented through to defensive assets, and include domestic and global equities as well as property, cash, fixed income and a mix of all – depending on your investment horizon and objectives.

Benefits of investment bonds

Investment bonds have a range of features that make them ideal longer-term investment vehicles. 

Tax effective structure

An investment bond is a tax effective structure; tax is paid within the investment bond rather than personally by the investor. 

The maximum tax paid on the earnings and capital gains within an investment bond is the company tax rate of 30%, although franking credits and tax deductions can reduce this effective tax rate further. This makes investment bonds a particularly attractive investment vehicle for high income earners.

If the investment is held for 10 years, no personal tax is paid. However, if the investment is redeemed within the first 10 years, tax will be payable on the assessable portion of growth as shown in figure two.

No annual tax reporting

As long as your money remains invested, the manager of the investment bond will pay tax on investment earnings; there is no requirement to declare those earnings in annual tax reporting. 

No limit on investment amount

There is no limit on the amount that can be invested to establish an investment bond. Importantly, investors can make subsequent investments up to maximum of 125% of the previous year’s contribution without restarting the ten-year period. 

Additional investments can be made annually or as a regular contribution. This way, parents can initiate an investment bond to help their children save toward a home and make either regular or ad-hoc additional contributions. As the children get older and start working, they too can contribute. 

Transfer of ownership

The ownership of the investment bond can be easily assigned or transferred at any time. The original start date is retained for tax purposes. 

Paid tax-free to nominated beneficiary/ies

Once the ten-year investment period ends, or in the event of the death of the investor, the investment bond is paid tax-free to the nominated beneficiary/ies. 

Case Study

Matthew and Jane are a hard-working professional couple with a 15-year-old daughter. They have been concerned about rising property prices and have heard from friends first-hand about the difficulties faced by first home buyers to afford a property. In fact, a number of their friends have drawn down on their mortgage to assist their children buy their first home, something Matthew and Jane would like to avoid. 

Matthew and Jane’s goal is to fund a deposit for their daughter’s first home. Based on a national median house price of $780,877 and the median unit price of $546,422, a 20% deposit of approximately $110,000 would be needed to buy a unit without the need for lender’s mortgage insurance. 

Mathew and Jane have saved $25,000 in a cash account for Chloe. They both pay the highest marginal tax rate and want to access the investment in 10 years’ time when Chloe is 25 and ready to take on the responsibility of a mortgage. 

They consider other options such as gifting or loaning the deposit to Chloe or acting as guarantor and signing as joint borrowers on Chloe’s loan. Their adviser explains the advantages and disadvantages of each option and recommends they invest the $25,000 into the growth option of an investment bond.

 

Matthew and Jane believe they can afford to add between $5,000 – $10,000 to the investment each year. As illustrated in figure three, either way they should at least cover the deposit – and where they can make higher contributions, they can provide Chloe an especially good start with her mortgage.

Consider a tax-effective investment plan

There’s no reason for parents with the financial means to help their children purchase a home or start a business shouldn’t provide that help if they want to. At the same time, it’s equally important to be realistic about the consequences of dipping into savings, or deferring retirement to continue supporting grown-up children.

Setting up an investment plan which is tax-advantaged, yet flexible, low cost and which allows for easy additional contributions each year, is one way of ensuring that the funds to help support children in an increasingly unaffordable housing market will be there when they are most needed.

Note: This is a sponsored article

Published: Monday, April 30, 2018


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