A good man we know is 45 years old. He is a professional, married with two teenage kids. Once or twice a week he visits his mum, a widow who lives alone in a nearby suburb. Without fail, every time he visits, he goes to the fridge and helps himself to anything there that takes his fancy. And neither he nor his mum think this is in any way unusual.
Both our friend and his mum share a common understanding: that a mum never stops wanting to provide for her son – even when he is 45, reasonably wealthy and is actually spending a lot of his time looking after her! There’s just something natural about older generations wanting to help out their children and their grandchildren.
This is especially the case when it comes to money. While Australians have never been wealthier on a per capita basis, much of our wealth is skewed towards older homeowners. Indeed, the family home (and investment properties for those lucky enough to have one) accounts for about 60% of all household wealth in Australia (source: Household, Income and Labour Dynamics in Australia survey, 2014). As everyone knows, housing has become increasingly expensive over the last 25 years. So, older Australians tend to possess more of this form of wealth. As we say, it is quite natural for older generations to want to pass on at least some of this wealth to their children and grandchildren.
There are various ways to do this. Anecdotal evidence suggests that up to 60% of private school fees are at least partially funded by grandparents. Helping pay for the grandkids’ education is an obvious way for grandparents to help younger generations within their family. But it is not the only way. Indeed, it is often not even the best way. It is quite common for older people to seek advice from financial advisers about the best way to help up-and-coming generations. Often, they are asking about specific ways of helping, such as setting up scholarship funds for grandkids, etc.
Each case is different, and so each situation needs to be addressed uniquely. That said, there is a fundamental principle that underpins all provision of financial assistance.
That principle is simple: the best way to help younger generations financially is to help them maximise their own wealth. Sometimes, this will involve paying specific expenses such as school fees. More often it is about taking a longer-term view about wealth. After all, if grandma and grandpa help their adult kids maximise their wealth, those adult kids will be better able to meet their own expenses such as school fees.
As the Hilda survey showed, approximately 60% of Australian household wealth lies in family homes. So, anything that older generations do to assist their children and grandchildren to own residential property will go a long way towards maximising the wealth of those younger generations.
Think of a simple example. An older couple have two grandchildren, currently aged five and three. They know that their grandchildren’s parents (that is, the older couple’s son or daughter) want to send them to private schools for their secondary education. The first school fees, therefore, will be payable in about seven years’ time. Many grandparents would be tempted to set up some sort of educational savings plan – and that makes sense. After all, having a plan is what good financial management is all about.
But let’s now consider the other very likely element of this situation: the grandchildren’s parents probably have a mortgage. If they are paying 5% interest on that mortgage, then repaying any principal for that loan will effectively be earning 5% per annum. What’s more, because interest on a home loan must be paid after tax, the effective pre-tax rate of earning can be as high as 9%, depending on the marginal tax rate that applies to the borrower.
Because of this, maybe the best way for grandma and grandpa to help is to make some extra repayments off the mortgage. If their grandchildren’s parents continue to make the same level of repayments, this will further accelerate debt reduction, and (provided housing prices do not fall spectacularly) in seven years’ time the borrowers will be likely to have established substantial equity in their home. At this point, when secondary school is starting, they could either reduce the rate of their own repayments or even redraw on that equity to help finance the school fees. After all, what is wealth for other than to allow you to buy the things that you think are important?
Paying off a non-deductible home loan is typically step number one on any wealth creation strategy. And if grandma and grandpa really want to help their grandchildren, the best way to do it is to help those grandchildren’s parents be as wealthy as possible. That is why the best advice to grandparents is often to help their adult children get out of debt as quickly as possible. Sure, it is boring. But it is also very effective.