INTERGENERATIONAL FINANCIAL PLANNING
Assistance buying homes without inheritance
Family home and aged care - to keep or not to keep?
Benefits of retaining or selling the family home from moving to aged care
Deciding whether to keep the home - key factors
The family home and fees payable in aged care
Chapter 1 - Assistance buying homes without
Assisting Younger Generations to Buy a Family Home (or a Better Family Home)
As the above graph makes clear, most inheritances occur after the recipient turns 48. By that age, the recipient is already well into their own peak cost years – the years when they are raising children. The following graph comes from the University of Canberra’s National Centre for Social and economic Modelling’s (NATSEM) 2013 report, ‘The Cost of Raising Children in Australia.’
As the graph shows, the proportion of household income that is spent on children is high throughout their life, peaking once they turn 18. Unfortunately, inheritances, when they come at all, usually come after the kids have been raised.
How handy would an inheritance be if it was received earlier in the recipient’s life – when they most need it, but before their benefactor actually dies?
For this reason, increasingly, older clients are looking for ways to assist adult children to buy their own home while the older client is still on the planet. Ways to do this include:
Buying a home in conjunction with a child;
Guaranteeing a loan to assist a child to buy his or her own home;
Utilising interest offset accounts such that the older client’s savings can offset the younger person’s mortgage;
The older client gifting some money to the adult child; or
The older client making a soft loan to the adult child.
We discuss each of these in the next section
Buying a home in conjunction with a child
Some young clients buy homes as co-owners with their parents. Their parents usually provide 100% of the deposit, guarantee the loan and generally make the project work.
This strategy has worked for some clients, but it is not for everybody. The reason is simple: the client ends up only owning half a home. For some people, half a home is better than no home. For others, half a home is less than they want and less than they need.
But at least this strategy has them on the path to wealth.
The strategy can work best where the adult child is an only child (or, if there are siblings, the parent co-owns similar properties with all of them). In this case, owning the property as joint tenants can be a good idea. Under a joint tenancy, when one owner dies, their interest in the property simply passes to the other owners. Where the two owners are parent and child, the usual expectation is that the parent will die first. If that happened, the child automatically comes to own the rest of the property.
The alternative is to own the property as tenants in common. In a tenancy in common, the ownership interests are separate and can be sold to third parties (subject to any co-owner’s agreement) or bequeathed to third parties under a will.
Your decision as to which method to use will depend on your specific circumstances. Advice as to whether to own a property as joint tenants or tenants in common is actually legal advice. Through our relationship with MLA Lawyers, we can provide a low-cost way for you to ensure that you get your co-ownership arrangements right.
Guaranteeing a loan
Anecdotally, more than two thirds of first homes are bought with significant parental assistance, usually in the form of deposit gifts, repayment subsidies, extra security and guarantees.
Of these, often the best form of assistance is a parental guarantee. You can read more about parental guarantees on the St George Bank website, here
Done prudently, normally there is little risk with a client’s parent providing a guarantee. Think about it: the parent is only exposed to the possible drop in value of the property. History suggests that this is probably not a great amount. Once a few years have passed the risk usually disappears, as the property increases in value and the equity builds. And if a client is facing a default on their loan, they can always try to earn a bit more by working weekends or nights if they have to.
(In extreme cases, the parent might even do this themselves).
We think parental loan guarantees for young clients often make a lot of sense. They mean the young client can buy more house, sooner, and this usually means more capital gain for less effort. Realistically there is not much risk for the parent.
Common sense is needed but within limits parental guarantees are an idea that should be contemplated whenever a younger person is looking to buy a home.
Interest offset accounts
Many lenders will allow clients to have one or more savings accounts that are matched to a home loan and offset the amount owed on that loan. The effect of this is that the amount of interest charged is reduced. Some lenders will even allow more than one savings account to offset the loan. Here is how Bankwest explain the effect of $5,000 held in an offset savings account linked to a loan of $300,000.
Where an adult child has a mortgage, and there is a scope for there to be more than one offset account, it can be a good idea for the adult child’s parents to use one of these savings accounts as their own bank account. This allows their adult children to enjoy the benefits of offsetting the interest on their home loan, while the parents (who have access rights to the account) still control their money.
The interest saved on the home loan will always be more than the parents will receive if the cash is held in a savings account in their own name. For example, the children might be paying (a non-deductible) 5% on their home loan while the parents only receive 1% (potentially taxable) on their savings. This means that the family is much better off if the parents’ money is used to offset the child’s mortgage account.
Some families even ask the child to pay the parents the lower interest rate on the savings (that is, what the parents were going to get). This is still a win, as the child is avoiding a much higher interest rate, and the parents do not lose.
Typically, the savings account offsetting the mortgage needs to be in the same name as the mortgage account. This means that money being used in this way is, prima facie, the legal property of the mortgage loan holder (that is, the child). For this reason, this form of arrangement should be coupled with an agreement between the parents and their child (and the child’s partner if there is one) such that the legal right to the cash in the account is passed back to the parent. A simple way to do this may be for the child to declare that the amount in the account is being held on trust for his or her parents.
This declaration should occur in some form of legal agreement. We can assist you to obtain quality legal advice at a very competitive price if you need assistance here.
One more thing to note: parents who ‘give’ their children money to use in an offset account will be deemed to still have that money for Centrelink purposes.
Gifts or soft loans
Many parents simply give their adult children cash gifts, either as a lump sum at the start of the home purchase to help with the deposit or regularly over the life of the loan. These parents need to remember that the gift means that the money becomes their child’s property. If their child is in a relationship, then the money can actually become part of the property of the relationship. If the gift is for a large amount and/or there is a risk of a relationship going ‘sour,’ then legal advice should be sought.
‘Soft’ loans are loans that only need to be repaid in certain circumstances (such as if and when the adult child sells the home being purchased). Once again, they can be a good way to help with the deposit and to ease the non-deductible debt burden. The fact that the money is a loan means that it does not become the property of the younger person and thus it will usually not become part of the relationship assets in the event of a relationship ending. Obviously, these loans need to be property documented as loans and can even be secured with mortgages to give maximum asset protection if a family law or bankruptcy event occurs.
Assisting Older Generations to Buy a Family Home (or a Better Family Home)
Sometimes, it is the younger generation that is in a position to help the older generations buy homes. This is often the case where the older generations were the original immigrants to Australia, for example, and arrived with limited employment prospects. The children of immigrants have long been over-represented among the ranks of academic achievers, and this correlates with higher earnings for those children.
In these situations, many of the techniques commonly associated with older clients helping their children can simply be reversed. A younger client might co-own a home with his or her parents, for example. Or, a young person might use their savings to offset a mortgage for their parents.
For higher tax-paying younger clients, the tax advantaged nature of the family home can be of assistance. If the home is wholly-owned by their older relative, with the younger client then to inherit it when their parent or grandparent dies, then there will be no capital gains tax payable when this happens. (Against that is the obvious fact that interest on any money borrowed to finance the purchase is not deductible along the way).
The Importance of Written Agreements
While most people consider their family to be a single economic unit, the law does not. For that reason, transfers of wealth between generations should usually be supported by written agreements between the participants. This can often be overlooked.
For example, if a client gives money to another person to be used towards buying a home, then that money becomes the property of that other person. If this other person is married, for example, then the money actually becomes part of the assets of the marriage – and can be distributed accordingly if the marriage ends.
Superannuation and Family Homes
Very commonly, the main focus of IFP is to provide housing for the younger generations – at least, housing that is within a sensible distance of where Grandma and Grandpa are living.
Accordingly, it pays to remember that, ultimately, private housing must be bought using after-tax dollars. The deposit used to purchase a private residence, for example, must be saved after tax is paid on the purchaser’s income. The principal and interest payments on the loan must also be paid out of after-tax income. Ultimately, the whole property is paid for after-tax.
As a result, it becomes clear that, where the tax payable on income is lower, it will require less pre-tax income to buy the same amount of house. The following table shows how much pre-tax income is required to buy a $500,000 property for various marginal tax rates.
The second column shows the pre-tax cost of a $500,000 property. The 15% tax rate is that rate payable on deductible super contributions into a super fund. The point of the table is this: if families make deductible super contributions into someone’s super fund, and then withdraw these contributions tax-free when the relevant person reaches the required age and use the money to purchase housing, the family only needed to earn $588,000 pre-tax to buy a $500,000 property. If the relevant part of the family instead pays tax on income at 45%, and then uses what’s left to purchase the property, the $500,000 property costs over $900,000 in terms of what must be earned to buy the home.
Judicious use of super can reduce the time taken to earn enough to buy a property by more than a third.
Because of this, wherever a property needs to be purchased somewhere within a family structure, it pays to think about whether the tax advantages of super can be realised.
TIM AND JOBE
Here is an example of how this might work. Tim is in his early sixties. He became a dad at 35 and his son Jobe is graduating from Uni at the age of 27. Jobe wants to save $40,000 over the next three years for use as a home deposit.
Tim’s adviser Noni has a good idea. Tim earns $80,000 a year as a senior administrator. Noni suggests that Tim sacrifice an extra $20,000 in salary as a deductible super contribution each year for the next three years. Given his tax rate, this only costs him $13,500 in lost purchasing power each year. He replaces this lost purchasing power by asking Jobe to pay board of $1,100 per month – the money he was intending to save for his deposit.
Within his super fund, Tim accumulates an extra $17,000 each year, after tax. If this is held in a conservative investment (akin to the term deposit), he can expect to have around $52,000 in three years’ time. Having reached the age of 65, he can withdraw this amount tax-free and use it as he sees fit – basically, his first order of business upon retirement is to help his son get started financially. Tim can give Jobe almost $10,000 more than he would have if he saved the money in his own name.