Wealth structuring is certainly not the preserve of the ultra-wealthy, and there are a number of strategies families should consider to ensure that their wealth has maximum benefit for generations to come.
The younger generations are getting into record amounts of debt today, leaving many parents – and grandparents – feeling they need to step in to save the next generation’s financial future. But raiding your own wealth to lift the debt burden could prove very unwise.
Wanting to help your children and grandchildren financially is a natural instinct, and particularly so for those of the Baby Boomer generation who see the young facing far greater challenges than they themselves did. In fact, Aegon research shows that one in five retirees would choose to gift any extra money that they had to the next generation before thinking of themselves.
A toxic mixture of rising student debt and house prices, alongside stagnating wages, have created a real need to help children get onto the housing ladder (even if they are middle earners). So far, so sensible. But what about affluent individuals raiding their own wealth reserves to get adult children out of debt?
There is no doubt that Generations X and Y (roughly, those now their twenties and thirties) have had a tough time building wealth in the years since the Global Financial Crisis. But what is now also coming to light is how these travails – and easy credit – have created a “debt culture” among the younger generations and problems that the older ones feel increasingly obliged to sort out.
Incredibly, insolvency figures show that the number of under-25s facing bankruptcy has risen tenfold in the past three years and experts are warning that this is just the tip of the iceberg when it comes to next generation debt. Much of the blame has been laid at the feet of the lifestyle competition that is social media and the overspending encouraged by the plethora of easy credit routes now on offer, many of which are just a few taps away on a smartphone.
Incredibly, insolvency figures show that the number of under-25s facing bankruptcy has risen tenfold in the past three years and experts are warning that this is just the tip of the iceberg when it comes to next generation debt
But of course, spiralling debt is not just about the younger generations living beyond their means to present an Instagram-worthy lifestyle. Today’s graduates face £50,000 of student debt (and interest charges of over 6%) while it is estimated that renting eats up over a third of young people’s incomes. The average age of a first-time buyer is now 33 and that delay in getting onto the housing ladder means that even the most diligent of thirty-somethings can find themselves still playing financial catch-up at the point when they want to start their own families.
Whether children have got themselves into debt frivolously or simply through the additional financial pressures of life today, the urge to step in will be strong (particularly where eye-watering interest rates factor). Many parents and grandparents will also feel that they have a new-found ability to help.
Pension freedoms introduced in 2015 mean that over-55s can now access their pension savings flexibly. Meanwhile, swingeing cuts to the tax reliefs available on rental properties is sparking an exodus from buy-to-let and a flurry of sales is expected before further reforms come into play in April 2020. Then, there are the desultory interest rates on savings likely to have many thinking that they may as well seek an emotional return on their capital instead, by using it to help family with debt.
This generosity may carry a heavy cost, however.
At findaWEALTHMANAGER.com we always advocate looking at wealth from a whole family perspective. Most of us wish to pass the wealth we have built on down the generations and a more strategic approach creates abundant opportunities for tax efficiencies (as well as greater familial harmony about money matters). But there could be great danger in taking this too far when it comes to tackling next generation debt.
We certainly encounter a lot of questions from our HNWI users focused on how they can best help family financially. Lifting debt, helping children onto the property ladder, helping with educational costs and how to transition wealth down the generations effectively all feature highly in our conversations. While it is of course tempting to keep things informal, taking a more strategic approach will ensure that any help you offer has maximum benefit for both you and the recipients. Never neglect the tax side of things either, or well-meant gifts could leave a nasty aftertaste.
The biggest danger – and a very much underappreciated one – is that those generous individuals raiding their pension funds or property wealth end up irrevocably harming their own financial wellbeing in the effort. Longevity risk (that of outliving your savings) is increasing as life expectancy rises and state support is rolled back. Retirees now have to plan for perhaps decades in retirement, and build up commensurate firepower in their pension pots to sustain their desired lifestyle throughout.
Retirees now have to plan for perhaps decades in retirement, and build up commensurate firepower in their pension pots to sustain their desired lifestyle throughout.
And it seems that many will be overestimating how great that firepower will be, even if they have saved to the maximum lifetime contribution allowance. Those who opt to draw down a reasonable 4% from a £1m pension fund each year can expect an income of £40,000, subject to tax (or £30,000 if their 25% tax-free personal allowance has been used). Then, it has been reported that those opting to buy an annuity may only get £21,000 a year from a £1m pot. Those contemplating a debt rescue must carefully weigh the effects of reducing these figures further through a pension fund raid.
Then there is the tax-efficiency side of things. Savers are entitled to access up to a quarter of their pension savings tax free, but using up this personal allowance in one go to gift a lump sum could greatly reduce your own tax planning opportunities later down the line. Don’t forget also, that the recipient’s own tax position may also be affected by a cash injection.
Even if the recipients of your generosity have every intention to help, a lot can happen over the years to destroy family wealth – not least divorce
More broadly, parents and grandparents might be thinking that clearing family debt is a good way to circumvent Inheritance Tax, and that family they have helped financially will help them in old age if needs be in return. Quite apart from the complex gifting rules that need to be taken into account here, is the precariousness of this position. Even if the recipients of your generosity have every intention to help, a lot can happen over the years to destroy family wealth – not least divorce. You should also consider the fairness of helping some family members financially and not others who may have been wiser with their money.
Of course, none of this is to say that better-off parents and grandparents should not help the younger generations of the family with their debts; rather, that this should be thought about very carefully first before being executed in an intelligent way.
Whether you are considering unlocking pension funds, deploying the proceeds of a property sale or otherwise raiding your savings for a debt rescue, we would urge you to take professional advice first. A wealth manager will be able to model projected retirement income streams for a range of scenarios which will help you see what is truly do-able without leaving your own long-term financial wellbeing at risk. They will also be able to look at the issue holistically to see what the most tax-efficient solution is for the whole family and how you can be most fair in dividing bequests.
A wealth manager will be able to model projected retirement income streams for a range of scenarios which will help you see what is truly do-able without leaving your own long-term financial wellbeing at risk
It is no doubt painful to see younger family members struggling with debt, but it will be even more so if an act of generosity now leads to your standard of living being greatly reduced later on. By all means, remove the debt burden from family if you can truly afford it, but make sure this is done in a clear-sighted way. You must be fair to yourself, and perhaps other members of the family, first.
Helping solve complex (and potentially delicate) money dilemmas is core to what wealth managers do. So, if you and your family need guidance on how to make wealth work harder, why not arrange for a no-obligation consultation with a professional adviser via our 3-minute search? Alternatively, please get in touch for an informal discussion of your needs with our expert team.