With young adults relying on parents to help with financing their housing, what are the broader wealth management implications?

A common issue in the UK – and certain other countries – is that the price of residential accommodation relative to taxed income is so high that many young adults struggle to get a mortgage, or event rent a decent place. This lack of affordability is probably a major reason why young people have turned to different radical politicians in recent years. At the same time, we are in the midst of a multi-trillion intergenerational wealth transfer – at least for the high net worth end of the population. To some degree then, younger adults are relying on their parents to help them out when it comes to housing. This carries a number of risks.

Addressing this issue and its wealth management implications is Stephanie Brobbey, a senior associate in the private client team at Goodman Derrick, the London-based law firm. 

The editors of this news service are pleased to share these views and invite readers to respond. The team does not necessarily agree with all views of guest contributors and invites responses. Email tom.burroughes@wealthbriefing.com

Every parent wants to give their child the best start in life. Many are prepared to make considerable sacrifices in order to see their children officially transition into adulthood, notably by helping them get on the property ladder. Indeed, the “Bank of Mum and Dad” continues to be a major player in the UK housing market. A report produced by Legal and General earlier this year found that 27 per cent of all buyers will receive help from friends or family in 2018, up from 25 per cent in 2017. 

Wealthier parents tend to be more concerned about giving their children as much as possible during their lifetime. This is not always solely driven by a desire to mitigate inheritance tax. Increasing life expectancy means that children have to wait longer to inherit from their parents; the demands of the modern world are such that they need access to financial resources at a much earlier stage in order to get established in life. Clearly, however, wealthy families are mindful of maximising tax efficiency in the context of their lifetime giving. If made in a tax efficient manner, lifetime gifts can significantly reduce the amount of inheritance tax payable on death. But what are the potential inheritance tax savings?

Broadly speaking, inheritance tax is charged at 40 per cent on the value of an estate which exceeds £325,000 ($416,217). Depending on the nature of the estate, it may be possible to claim additional tax free thresholds, exemptions and reliefs to reduce the inheritance tax liability. However, any available exemptions and reliefs may not eliminate the tax bill altogether, especially if you are leaving assets to your children on death. In any event, this is only part of the inheritance tax journey. 

While the starting point is to look at the value of your estate at death, HMRC requires you to go back seven years before the date of death to see if you have made any lifetime gifts within that period. To the extent that gifts were made during that period, these will be brought back into your estate to calculate the inheritance tax due on your estate. There are some exceptions. Currently, everyone has an “annual exemption” which means they can make £3,000 worth of gifts in each tax year without straying into the seven year quagmire. There are also concessions for wedding gifts; each individual can give up to £5,000 per child or £2,500 per grandchild. 

The bottom line is that if you are fortunate enough to be in a position to give your children more than £325,000 in the seven years preceding your death, those gifts will likely be subject to inheritance tax along with the assets you actually own at your death. It is important to note the default position regarding taxable lifetime gifts is that the recipient of the failed gift has to pick up the tab for the tax bill rather than the estate. 

It is interesting, if a little disconcerting, to note that parents seem to be supporting their beloved offspring over and above the provision of shelter and possibly a wedding fund; and well into adulthood at that. The Social Market Foundation recently published a report which indicated that one in ten people in their forties is receiving regular financial support from their parents. According to the think tank, the most common reason for providing support is to help family members meet the cost of daily living. The data suggests that financial help from parents is now a monthly lifeline rather than a strategic passing down of wealth to the next generation as part of a sophisticated estate planning exercise. 

Ostensibly, this might seem an entirely practical way of helping out younger family members. From a tax planning perspective, the new trend dovetails nicely with the “normal expenditure out of income” exemption. This exemption enables individuals to make recurring gifts out of surplus income, without being caught out by the inheritance tax rules. In order for the exemption to apply the following criteria must be met:

1. The gift must be made as part of normal expenditure; 

2. The gift must be made out of income; and

3. After taking account of all gifts forming part of normal expenditure, the individual must be left with sufficient income to maintain their normal standard of living.

While this can provide a tax efficient approach, using this exemption in the context of providing monthly support for household bills and the expenses of grandchildren could be a worrying symptom of adult children trying to stay afloat in an increasingly expensive world.

It would be deeply depressing to live in a society that criticises parents for demonstrating altruistic tendencies towards their children. However, in reality, we ought to reflect on just how sustainable these arrangements are and consider the knock-on effect for parents whose adult children remain financially dependent on them. After all, following a lifetime of hard work many feel strongly that they ought to be enjoying themselves “SKIing” (otherwise known as spending the kids’ inheritance) instead of acting as a benevolent overdraft facility. 

There is a real danger that, in subsidising their children’s lifestyles, parents may compromise their own standard of living and put their own financial security at risk.  With people living longer and the rising costs of elderly care, parents should think carefully about whether they can really afford to continue supporting their adult children.  Equally worrying is the idea that we have a financially illiterate younger generation living beyond their means because the Bank of Mum and Dad underwrites their lifestyle choices.  

Are these generous parents quietly feeding the beast to the detriment of their children’s long-term financial future, or is it possible that our world view has become so far skewed in favour of individualism that we are horrified by the prospect of providing ongoing support for family members? Whether the principal motivation for making gifts is part of a succession planning strategy or a necessity to keep loved ones afloat, current trends do raise interesting questions about financial interdependence across generations and the need for financial literacy.