This week’s Investing Compass episode explores how to incorporate an expected inheritance into your financial plan. It also explores the other end of the stick – how you could consider leaving an inheritance to loved ones in the way that makes the most sense to you.

This conversation has been one that has been highly publicised in the recent past. What drove this frenzy of media activity is a report by global property consultant Knight Frank.The report cited $90 trillion is expected to be transferred over the next 20 years.

This makes for a good story. I think many millennials have been frustrated with the economic climate. Many of the traditional markers of success and adulthood have seemed out of reach. Housing prices are significantly higher than when compared to wages than they were for previous generations. The costs of tertiary education is significantly more expensive than it was for previous generations.

This has resulted in more debt. Personal debt (debt that is not tied to an asset), millennials are the most indebted, with an average of $56,000 in debt for each Australian millennial.

The podcast runs through two key issues in relation to receiving an inheritance. The first is how the funds are passed on. The second is the timing. These two factors significantly impact the way inheritances are received, the taxes and the final amount that is received.

Given these avenues, we go on to discuss how inheritances should be integrated into financial plans. We want our financial plans to cover a variety of scenarios and this is very much the case when it comes to inheriting money. It is easy to dismiss inheritances as a subject that many of us don’t think about. In reality, some of us use the vague notion of a future inheritance to justify making poor decisions with money.

People love to mentally spend money or account for money that hasn’t been received yet. For example, somebody may make financial decisions they wouldn’t normally make in anticipation of getting bailed out by a lump sum. Perhaps they won’t save and justify that by this future inheritance. Or even worse, perhaps they will go into debt in anticipation of paying it off with an inheritance.

The problem that many people run into is that most of the time with an inheritance we don’t know how much we will get and we don’t know the timing.

Listen to the episode below to understand how, if at all, inheritances should be included when planning for the future.

You can find the transcript to the episode below:

Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Mark Lamonica: All right. So, Shani, today we're going to talk about millennials, which I know is a generation that's close to your heart because you are a millennial.

Jayamanne: Well, I'm looking forward to hearing your thoughts about millennials, Mark.

Lamonica: Okay. Well, here's a couple of things. You know, the oldest millennial was born in 1981. And I was born only a year-and-a-half prior to that. So, I'm not that far off from being a millennial, but you always call me a boomer, which was the generation I looked this up to, those born between 1946 and 1964.

Jayamanne: I've never called you a boomer, Mark.

Lamonica: You call me a boomer all the time.

Jayamanne: Well, we shouldn't let facts get in the way of a good joke.

Lamonica: Yeah, apparently not. But now that millennials have moved into middle age, your generation is being ignored, so both in good and bad ways. So, you're no longer the punching bag. That's moved on to Gen Z. And they've taken over as this entitled generation that doesn't work hard, which will soon be passed on to a new generation that will be called lazy entitled titled because that's all we do. We just keep calling young people that. But it also means that nobody cares what you think anymore, right? From like a marketing perspective, nobody is marketing you, nobody is creating products for you, nobody is asking your opinion. So, I don't know, how do you feel about this whole situation?

Jayamanne: I feel like that's a pretty broad generalization, but I'll leave that to you.

Lamonica: Okay. Well, today we're going to talk about some recent coverage in the media about millennials. And basically, what it is said is that millennials are set to become the richest generation in history when an estimated $90 trillion of wealth is passed on to millennials.

Jayamanne: Yes, the intergenerational wealth transfer is on everybody's lips, at least in the financial community, as asset managers and advisors are looking to engage with millennials to earn fees, to help millennials manage this soon-to-be inherited wealth.

Lamonica: Yeah, and this is another generational rite of passage, right? At some point, the financial services industry decides a generation as money and then starts paying attention, which I think is something that millennials should worry about. I don't know if that's something you're worried about, Shani. But…

Jayamanne: Well, I don't know if I'm going to inherit anything close to $90 trillion, but let's start with some facts. What drove this frenzy of media activity is a report by global property consultant, Knight Frank. The report cited this figure of $90 trillion that is expected to be transferred over the next 20 years.

Lamonica: And that sounds great in theory, and it makes for a good story. I think many millennials have been frustrated with the economic climate, so many of the traditional markers of success and adulthood have seemed out of reach. So, of course, housing prices are significantly higher than when compared to wages for previous generations, the cost of uni and other forms of education are significantly more expensive than it was for previous generations. And yeah, I don't know, are these your millennial grapes?

Jayamanne: Moving on. This, of course, has made a lot more debt, and there are tons of stats that we can talk about. If we look at personal debt, which is debt that is not tied to a mortgage or an investment property, we can see that millennials are at the top of the charts with an average of $56,000 in debt for each Australian millennial.

Lamonica: And obviously, mortgage debt is a lot higher for millennials that are lucky enough to own a home. And CBA presented some interesting stats back in August of 2023 that looked at the bank's deposit and loan book divided by ages. And unsurprisingly, it showed the majority of deposits were held by individuals 65 and over, and the majority of loans fell into the cohort between 35 and 44.

Jayamanne: The same study showed that younger people are struggling the most and are reducing spending to deal with higher cost of living and servicing this debt. They just don't have a financial cushion to absorb the run-up in price of almost everything.

Lamonica: And that, of course, is what this intergenerational wealth transfer is really all about. Older people have benefited from huge run-ups in asset prices. They have paid back their debt, and they have lots of money. Young people are either heavily in debt to own assets like homes, or they just don't own them at all and have little room in their budgets and small savings buffers for increases in the cost of living. So, they are forced to cut back spending to pay for life.

Jayamanne: And I think housing is an interesting prism to view this dynamic. The current older generations bought houses when they were relatively cheap from a price-to-income ratio, which means that regardless of the level of interest rates when they took out their original mortgages, the loan size was relatively small compared to today when we look at the debt in an income perspective. Then interest rates dropped significantly, which made servicing the smaller amount of debt cheaper and made housing prices go up significantly.

Lamonica: Yeah, which I think is an interesting point that gets lost in this argument that mortgages used to be 18%. So previous generations had it just as hard as millennials and Gen Z do today when it comes to buying a house. And maybe that would be true if mortgages had stayed at 18%, but of course they didn't. They kept falling and falling. And if housing prices had just risen by the same rate as wage growth, it would have been a good argument. But of course, that didn't happen. So, the point is not to discuss generational conflict today.

Jayamanne: Are you sure?

Lamonica: I am sure. I am sure. The point is to look at the impact of the generational wealth transfer and how both the people transferring the money and the people expecting to get the money should view this in light of their personal finances.

Jayamanne: I agree, but I'd like to make one final point. When we look at these overarching stats by generation, we tend to lose the fact that not everybody is the same. Not every member of older generations has amassed a lot of wealth, not every millennial will inherit money, and not every millennial has a huge debt burden. Over the lifetimes of older Australians, there has been a large increase in wealth inequality. So naturally, this wealth transfer will proportionally go from wealthy members of older generations to their kids, who are also likely relatively wealthy compared to their own peers. This is likely to exacerbate income inequality. Also, the people without wealthy parents with lots of assets may have to support their parents in old age, which is another drain on their finances before inheriting nothing. Just another dimension around this whole topic.

Lamonica: Yeah. No, I certainly agree, Shani, and the risk of annoying a lot of people there is a simple solution. If most Australians hold most of their wealth in houses and younger generations do not have access to the bank of mom and dad, struggle to buy property, maybe a good way is just to bring down housing prices. But of course, we know that's not going to happen.

Jayamanne: All right. Let's leave our soapbox there. Today, we are going to cover how someone can think about the wealth transfer if you are someone expecting to get an inheritance and if you are someone expecting to provide wealth to your children.

Lamonica: Okay. So, there's two key issues in relation to receiving an inheritance that we're going to touch on. The first is how those funds are passed on, and then of course, there's timing. And we can start with how the assets are passed on. There is no inheritance tax in Australia, but that does not mean that taxes are simple. If appreciated assets like a share portfolio are passed on, there won't be any tax upon the transfer of those assets. However, the capital gains on those appreciated shares will still be owed by the beneficiary when and if they're sold.

Jayamanne: And this complicates things in two different respects. The first is simply for people that inherit wealth to understand they're not actually getting what they think they will get. If you inherit a million dollars' worth of shares, but there's tax owed when those assets are sold of $200,000, you're only really getting $800,000. Now, obviously, we're just making up numbers here and I don't think anyone is turning down $800,000. But if you are incorporating an inheritance into a financial plan, just be aware that while there will not be tax due when you inherit the assets, you may have to pay them down the road. This is obviously especially critical if your plan is to dispose of the shares and use the money for something else.

Lamonica: Okay. So, let's talk about the implications of capital gains tax with inherited securities. There are reasons that people hold assets outside of super and outside of their primary residence, which we'll get to in one minute. But in terms of outside of super, the first reason is because you can't get them into super. There are, of course, limits on how much can be contributed to super on a concessional and non-concessional basis. But there's another reason. Super is fantastic from a tax perspective, but it does come with limitations on when you can access the money. Holding money outside of super has none of these limitations. So, for instance, if you're hoping to retire early, you need assets outside of super, which is great from a flexibility standpoint, but of course comes at the cost of higher taxes.

Jayamanne: So. let's think about a scenario where receiving appreciated securities outside of super works well. If you're inheriting the assets, max out your concessional and non-concessional contributions to super and want to keep those assets to support a goal like early retirement, this can align with your own plan. And really the question then is, are the appreciated shares you've inherited ones that you want to keep? Because even if you want assets outside of super invested in the market, you don't really want to sell them to buy different shares because once again, you'll trigger the capital gains. So, it really makes no difference if you want to sell the assets and buy different ones or if you want to sell them to use the funds for something different.

Lamonica: And this is going to be something that we're going to talk about a lot. The key here is communication, and nobody likes talking about death, but ideally, parents and children should talk. Transparency is beneficial. If a parent chooses to leave money to their children, they want the money to be useful. And it's worth talking to your kids about how they intend to use it. And the reason for this is because the tax situation can be managed prior to death.

Jayamanne: Tax situations are obviously unique, but let's run through a scenario here. In many cases, a retiree will have a lower marginal tax rate than their children who are working. In that case, the parent may want to take the capital gains hit. In other words, if you're a parent, sell the assets while you are alive, pay the taxes, and then hold those funds in a way that will benefit the child the most. Perhaps that's just in cash. Once again, this is very dependent upon differences in tax rates between parents and children, but this may be a way to save on tax.

Lamonica: The other scenario is if the parents and the children have different investment goals, which call for a different investment strategy. Same thing could be done. Start to sell off the appreciated assets and invest in a portfolio that aligns with what the receiver of the inheritance wants, so they don't have to sell the assets at a higher marginal tax rate after they've been inherited. Once again, this is a bit of a radical call. The level of transparency into the intentions of the parents and the intentions of the child is not something I expect as the norm, but it is worth considering.

Jayamanne: All right. Let's talk a bit about inheriting a primary residence. As long as a property is sold immediately, it retains the capital gains exemption for a primary residence. If it's an investment property, the same rules apply. CGT applies to gains.

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Lamonica: And finally, let's turn our attention to super. So, Shani, you actually wrote an article titled What Happens to Super When You Die. So, I'm going to let you handle this one.

Jayamanne: I did write it, but I didn't write that title. I think that was you, but I do love super.

Lamonica: What was the title then?

Jayamanne: No, that was the title, but you put the title on the article.

Lamonica: Well, it's dramatic.

Jayamanne: Okay. So, there are a few factors that will influence the size of the inheritance received from assets within the super system. Whether it's a lump sum benefit or an income stream, it can only go to a dependent. There are two definitions, super and tax dependents. Whether the recipient is defined as a tax or a super dependent will determine the tax that you do pay on it. The tax designation of the super asset, so if it's taxable, taxed, or untaxed and tax-free components, the components in each designation are available through your annual statements which you receive from your super or by contacting the superannuation fund and to the age of the deceased and the age of the beneficiary.

Lamonica: Perhaps now is a good time to say that you should talk to a tax professional.

Jayamanne: Yes.

Lamonica: But…

Jayamanne: And not get your tax advice from a podcast.

Lamonica: Yes, but that is obviously the overview, and I can try to define a couple of those terms. So, a valid dependent can be a spouse, like your current spouse, not somebody who has left you for somebody better, a child or any person that has an interdependent relationship. And that is really what we're talking about today. So, we'll stick with a dependent.

Jayamanne: All right. In most situations, the benefits are paid to a dependent and are tax-free. If it is to someone who isn't a dependent, there are taxes to pay. And this will usually be the case if it is going to your kids because they'll be over the age of 18. This is dependent on the split between the taxable and non-taxable portions of your super. So, the money is therefore outside of the super system and the beneficiary can do what they want with it. So, again, I think this is the case where communication is key. Just to make sure that both the person leaving the money and the person inheriting the money are on the same page and any potential tax issues can be taken care of in the most effective way based on the intended use of the money and the parents' wishes.

Lamonica: Okay. So, let's spend some time talking about how to think about a potential inheritance as part of a financial plan. We want our financial plans to cover a variety of scenarios. And this is very much the case when it comes to inheriting money. We can sit there and pretend that nobody ever thinks about inheriting money, but we both know that isn't true. And many people use the vague notion of a future inheritance to justify making poor decisions with money. So, Shani, why don't you run through a couple of examples of that?

Jayamanne: All right. So, many people love to mentally spend money or account for money that hasn't been received yet. So, for example, somebody may make financial decisions they wouldn't normally make in anticipation of getting bailed out by this lump sum. Perhaps they won't save and justify that by this future inheritance. Or even worse, perhaps they'll go into debt in anticipation of paying it off with an inheritance. We love to give ourselves any excuse to do something we know is wrong. And that can certainly be the case here.

Lamonica: And the huge problem that many people run into is that most of the time with an inheritance, we don't know how much we will get, and we don't know the timing. First, we can talk about how much. Now, I'm just going to use a parent as an example, but obviously this could be the case for anyone you may be inheriting money from. Many people have no idea how much money their parents have. Many people have no idea what their parents' intentions are. How is the money getting split among different family members, so that can be kids and grandkids? Are parents helping out some children and not others, and they choose not to share these details to reduce family conflict? Well, that obviously reduces the amount of money they have.

Jayamanne: The other issue involved in the question of how much is related to timing. We obviously don't know when the person will die that we are anticipating inheriting money from. If you have two parents that are married, both need to die before anything is passed along. The longer somebody lives, the more they will spend, but conversely, if they are investing, the more they may earn. But all sorts of very expensive end-of-life scenarios can happen also.

Lamonica: And the timing is another challenge for any type of planning for an inheritance. People are living longer, which of course means people are inheriting money later in life. According to the ATO, most people that do receive an inheritance don't get them until they are between the ages of 55 and 70. And that has implications, which we'll talk about in a second.

Jayamanne: The more specific you can get with any financial plan, the easier it is to do. Inheritance is really hard to plan for because you don't know the timing or how much you're going to get. So, I think more than anything, our financial advice and honestly, probably life advice as well, is to not make financial decisions around an inheritance. If you get one, that's a bonus. If you don't, you wouldn't have dug yourself into a hole that you can't get out of.

Lamonica: And we've been talking about how it's important to be transparent when there are multiple parties involved because that can benefit everyone, even if it's a difficult conversation. And I wanted to bring up a book that I recently read, and it got me thinking about this, Shani, and the book is called Die with Zero.

Jayamanne: I haven't read the book and I'm sure some listeners haven't either, so fill us in, Mark.

Lamonica: Okay. So, the book is by this guy named Bill Perkins and he was a successful Wall Street trader who came up with this financial and life philosophy. And the basic idea is exactly what it says in the title, plan to die with zero. And a good deal of the book is about how people should maximize their life experiences and therefore spend all of their money while they are alive. Now, this does not mean they shouldn't leave money to people and just spend it. Perkins just says that giving away money can also bring enjoyment, whether that is supporting a certain cause or giving it to your children or anyone else you want to support. The point he makes is to give it away while you are alive. Perhaps you can get some enjoyment out of seeing the money support the people that you love.

Jayamanne: I mean, that seems quite reasonable.

Lamonica: No, it does. And another point that Perkins makes is that the money will not only provide enjoyment to the person that is giving it away, but it will also be much more valuable to the beneficiary if they get it as soon as possible.

Jayamanne: Which is a really interesting point. As much talk as there is around this intergenerational wealth transfer, we need to be cognizant that lifespans are increasing. And as we said, most people that do receive inheritances don't get them until they are between 55 and 70. And this, of course, is well into many people's lives. Money that could have transformed your life if received when you were younger now may be less useful.

Lamonica: And I think this fits into our theme about transparency around the intended use and the intent of the giver. When the money is given prior to death, it can be an open dialogue with the added benefit of being more useful to the recipient. And this doesn't necessarily have to be a lump sum because of course people worry about running out of money. But incremental plan giving over the years can be a great approach as well, whether this is to a relative or to a charity.

Jayamanne: And that brings our episode on inheritance to an end. We hope this gave you some food for thought, whether you're planning on giving some money away or if you're lucky enough to receive it. Maybe this will be a catalyst to start having a conversation about inheritances with your parents or your kids. Yes, it is awkward, but in the long run, it will probably benefit everyone involved.

Lamonica: So hopefully, everyone enjoyed this episode. I know this is more relevant for some people than others, but it is never too late to find an old wealthy person and befriend them. Shani always buys drinks for old people that are in bars by themselves. And so maybe that's a good strategy.

Jayamanne: To be fair, they're ones that look like they wouldn't have much money. So…

Lamonica: You never know. You cannot tell how much money people have by the way they dress.

Jayamanne: That is true. I shouldn't make assumptions.

Lamonica: Exactly. But anyway, thank you very much for listening. We appreciate it.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)