CPD: The bank of Mum and Dad

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The Bank of Mum and Dad is the fifth largest lender behind the big four banks.

It’s a recent addition to the lexicon, but this phrase has become widely used and is one that a growing number of Australians can relate to. In this article, Centuria examines the rise of the ‘Bank of Mum and Dad’ and looks at strategies to help your clients avoid dipping into their savings to help their kids achieve their property aspirations.

According to research[1] undertaken by financial comparison website Mozo, the Bank of Mum and Dad is the fifth largest lender behind the big four banks – collectively, these ‘bankers’ have lent approximately $65.3 billion to their offspring.

Mozo concluded that 29 per cent of parents – or more than one million families – assist their children to buy a home. On average, the Bank of Mum and Dad lends $64,000 per family, a sum that 67 percent of lenders don’t expect to see repaid. What effect might this have on their retirement?

What is the Bank of Mum and Dad?

Quite simply, the ‘bank’ is any family willing to lend their kids money…and this could be any number of your clients. These ‘loans’ – which may or may not be repaid, in part or in full – can be for anything as agreed by the parties involved. While generally used for property related transactions, the Bank of Mum and Dad is also used to support business start-ups and entrepreneurial ventures. The terms are generally much easier than with a traditional bank!

Defined by the Oxford Dictionary, the Bank of Mum and Dad is:

(especially in the context of property purchase) a person’s parents regarded as a source of financial assistance or support.”

There are two ways the Bank of Mum and Dad provides financial assistance:

  1. Allowing the kids to live rent (and bill) free while they save for a deposit (or start a business) – according to Mozo’s research, that’s worth approximately $25,000
  2. Providing cash support for the deposit and/or repayments.

A survey[2] published last year found that conserving capital to leave money for the next generation is no longer a key consideration for older Australians; in fact, only 3% of respondents intended to preserve all their savings for the next generation, but only 10% expect to spend all their money on themselves. Instead, the report noted the trend away from a bequest motive in saving, to one that moved towards helping children with their first home during their lifetime. Importantly, the report also noted that becoming a Bank of Mum and Dad increased the risk of reduced savings and financial hardship for the older person later in life.

Research[3] from the United Kingdom, which has also experienced a housing affordability crisis, found the proportion of prospective buyers who expect to get help from family has risen 30 percent in one year. Nearly half (48 percent) of prospective first-time buyers expect to get some help from the bank of mum and dad.

What’s driving the next gen to the bank of mum and dad?

The prime reason for the emergence of the Bank of Mum and Dad is housing affordability. The cost of housing is being forced upward by a range of factors – the housing shortage, the relaxation of foreign ownership laws, historically low mortgage rates attracting investors into the market, favourable tax concessions and finally, the banks themselves, which have been offering interest only and other packages to attract investors into the residential property market.

Housing affordability – or lack thereof – has been dominating headlines for several years. The first hurdle is the requirement for, at minimum, a 20 percent deposit. That equates to a deposit of $173,142 based on Melbourne’s median house price, or nearly $250,000 based on Sydney’s median house price. This makes it increasingly difficult for first timers to get their foot on the first rung of the property ladder.

A report[4] published by researchers from RMIT and Curtin University for the Australian Housing and Urban Research Institute (AHURI) found the way the baby boomer cohort chooses to pass on their housing wealth to their children could prove to have an increasingly important influence on the welfare of generations X and Y.

The results suggested that 25 to 45-year-olds who received a cash gift from parents had home ownership rates 15 percent higher than their peers, lifting the proportion who owned a home from 45 percent to 60 percent.

Impacts on the ‘bankers’

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. While helping one’s children to get started on the property ladder is very noble, what happens to the retirement plans of the lenders?

Superannuation assets amounted to $2.5 trillion at 30 September 2017, yet another historical record. Despite this, there is plenty of media coverage suggesting that many Australians will not have sufficient savings to fund their retirement. According to the ABS, the average superannuation balance for Australians aged between 55-64 is $310,145 for men and $196,409 for women[5].

Figure one outlines the retirement lump sums required to fund a ‘comfortable’ retirement according to ASFA. The calculation assumes the retiree owns their home outright, draws down all their capital and receives a part Age Pension. These sums are significantly higher than the average balances projected by the ABS.

 

Source: ASFA – All figures in today’s dollars using 2.75% AWE as a deflator and assumed investment earning rate of 6 per cent. They are based on the means test for the Age Pension in effect from 1 January 2017.

The ASFA retirement standard assumes the retiree owns their own home outright; if a parent has borrowed against the family home to finance one or more children, they will need more retirement savings that those suggested by ASFA for a comfortable retirement.

In short, there are two potential outcomes for ‘bankers’:

  1. Parents defer their retirement to a later date
  2. Parents retire with reduced savings and/or an ongoing mortgage to service.

Is there a better way?

The better way is, of course, to plan ahead and save. Parents may establish a regular savings program when their children are young, or work with young adult children to undertake a co-savings program to reach a specific goal, such as the deposit for a first home. The benefit of the latter approach is to instil a savings mindset in the younger generation.

Using a savings account or term deposit to save for a first home has two drawbacks; the first, incredibly low rates of return, the second, a tax liability on income received. With such low rates, on an after-tax basis, the savings will struggle to keep pace with inflation.

There is however, a viable alternative – using an investment bond.

An investment bond is an insurance policy, with a life insured and a beneficiary, and it operates like a tax-paid managed fund. As with a managed fund, you can make recommendations to your client from a broad range of underlying investment portfolios. These typically range from growth oriented through to defensive assets, and may include:

  • domestic and global equities
  • property
  • fixed income

Underlying investments may comprise a single asset class, such as Australian equities, or a blended portfolio with a specific objective, such as a balanced, growth or high growth option.

Benefits of investment bonds as a savings vehicle

Investment bonds have a range of features that make them ideal longer-term savings 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 30%, although franking credits and tax deductions can reduce this effective tax rate. This makes investment bonds a particularly attractive savings vehicle for high income earners.

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

 

 

No annual tax reporting

As long as the client’s money remains invested, the manager of the investment bond will pay tax on investment earnings; there is no requirement for your client to declare those earnings in their 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 called Chloe. 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 Chloe’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.

 

 

While being a lender in the Bank of Mum and Dad is noble and understandable, it’s worth considering Shakespeare’s wise words in Hamlet, when Polonius utters the famous phrase –

“Neither a borrower nor a lender be / For loan oft loses both itself and friend.”

In other words, encourage your clients to not lend (or borrow) money from friends or family; they may lose both friend and money. Alternatively, they may have to defer their retirement while they build up their savings or pay off a mortgage; alternatively, they may have to embark on this new chapter with fewer savings and a mortgage to service, neither of which is an ideal start to retirement.

 

 

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[1] https://mozo.com.au/home-loans/articles/bank-of-mum-and-dad-the-fifth-biggest-home-loan-lender-report-2-17
[2] Seniors more savvy about retirement income, National Seniors & Challenger, June 2017
[3] The bank of mum and dad, Legal & General, August 2017
[4] A new look at the channels from housing to employment decisions, March 2017
[5] ABS 4125.0 – Gender Indicators, Australia, September 2017

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