Wednesday, November 30, 2016

Death, taxes and the inter-generational minefield

In the good old days – up to c.1979 – death and taxes in Australia were not merely the twin certainties in life; they were coupled together in a way which led to a clutch of secondary assumptions about wealth accumulation, holding (or not), and dispersal/transfer within average families.  State death (and gift) duties placed a kind of glass ceiling on capital gains, particularly over family homes and other unproductive real estate (i.e. that was mostly or entirely vacant).  Unproductive assets would hence tend not to spiral up in value because, even if – and in those days it was a big “if” – the acquirer “won” the game of speculation, there would be an eventual but (for most) inevitable day of reckoning with both grim-reapers.  For the middle-classes, at least, the taxman would take a heavy cut (although the wealthy could more easily sidestep death duties).       

This situation led to a virtuous circle in and for middle-class Australia.  Productive investments were more or less neutral for estate-planning (being taxed in both life and death), while spending one’s surplus wealth in retirement was gently encouraged – and here I mean actually spending it, as opposed to locking it up in unproductive real estate, such as renovations.  On the other side of the ledger – from the perspective of the adult children of the retirees – there was a distinct lack of angst about all this, in a way that today seems almost inconceivable.  But in days before real-estate price inflation became rampant – and a present-day inter-generational minefield, of which more about soon – it really was this elegantly simple.  The younger folk bought their own houses without reference to, or handouts from, their elders.  That they could afford to do this was, in turn, largely due to a thriving real (as opposed to real-estate) economy – when, once upon a time, retirees actually spent.

Since the 1980s, a countervailing vicious circle has taken hold.  Real-estate inflation has fed off the peculiarities within capital gains taxes (CGT), first introduced in 1985, and a national regime very different to the old death duties ones.  CGT has always exempted the family home and has, since 1999, generally been levied at a much lighter rate than income taxes.  Speculating (as it was once called, or “investing” as it is now more usually known) in unproductive or negative-income real estate has thus become a no-brainer for many.  Expensive home renovations, meanwhile, have become a similarly vacuous quasi-"bank" for both storing and flaunting wealth – a curious phenomenon that surely no 1950s futurist could have conceived of.  This was a decade when cutting-edge renovations meant an indoor toilet (fancy!) and a fresh coat of paint indoors every twenty years or so.  Plus, if you were really serious about keeping up with the Joneses in the 1950s, there was also a must-have accessory – an Albert Namatjira print hanging on the lounge-room wall. 

In 2016, there has been a ground-up re-writing of the middle-class former rule-book from the death-duties era about wealth accumulation, holding (or not), and dispersal/transfer within the family.   The young (and not so young) have become supplicants, while the old – baby boomers and older – have become hoarders.  When increasing life-expectancy in thrown into this mix, the outcome truly, as the saying goes, is on for young and old.

“Spending the kids’ inheritance” is usually said in a tongue-and-cheek way that belies its modern complexities, if not de facto impossibility.  This loose phrase would not seem to apply to money that is or could be got from unlocking the capital in the family home – if this is seen as “spending” money at all, it is of the serious, non-discretionary type; viz for entering aged-care, etc.  So the family home’s value is largely sacrosanct from discretionary spending – or properly hoarded, you might say – despite much of this store of value usually being an intrinsic windfall.    Retirees’ surplus spending money will thus mostly come from other sources – primarily investments.  However, because these monies are, on the whole, lightly taxed, particularly if inside superannuation, there is also a disincentive to spending them, compared to the good old days of death duties.   A tendency to “bad” hoarding, or miserliness, is thus structurally encouraged. 

While the degree of this will vary with the personality of each retiree – and so it is very hard to quantify on macro-scale – the prevalence of this type of hoarding is undoubtedly masked by what I call pseudo-spending:  on renovations to the family home, and perhaps also, more controversially, on staying on for one’s twilight years as a single or couple in a large family home (or a modest family home on a large or otherwise windfall value-increased block of land).  The latter scenario involves deep emotional factors, as well as complex economic rationalities, mainly to do with age-pension eligibility and aged-care bonds. 

But for all this, the matter of retirees’ discretionary spending in the real economy should not be overlooked. If this spending is perversely light – which seems to me to be the case – then “the kids’ inheritance” indeed comes to the fore, precisely because it is not sufficiently spent.  The adult “kids” (apart from those who work in the tax-advantaged real-estate and renovation industries) thus have fewer and less well-paid jobs (and pay more than their fair share of taxes along the way).  Meanwhile, real-estate prices continue to inflate, largely driven by the tax system. 

Here, you may still think that this situation will sooner or later resolve itself, and happily for all.  The kids will eventually get their inheritance – and the hoardier their parents were, the bigger the kids’ windfall will be, naturally.  But these are largely uncharted inter-generational waters. 

As well as the present Xer-and-younger (born on/after 1 July 1962, by my calculation) generations being, on average, poorer than their parents, now and probably also at death, longer life-expectancy is starting to see inheritances now commonly delivered when the “kids” are in their seventies (if not, although still rarely, even older).   For baby boomers – on average (much) richer than their Depression-child parents, despite the latter’s frugality – this may mean that the beach-house upgrade comes, annoyingly, a few years later than would have been ideal.

For retirement-age Xers-and-younger however, the timing of the inheritance is of much greater fiscal significance, particularly if they do not – ahem – yet have significant real-estate equity.   For such seventy-somethings, an inheritance may well be a case of Too Much, Too Late:  a disruption to receipt of the age-pension (if that even still exists for seventy-somethings from 2032) until the inheritance is spent on first-home buying, which real-estate may in turn be occupied for a only brief time before an aged-care bond comes knocking.  That said, here I may be privileging Xer hardship above baby boomer stresses.  With thousands of baby boomers now turning seventy every week, who am I to minimise the existential dread many must be feeling at this milestone; still beach-house bridesmaids in Blairgowrie (and Pittwater), and watching the biological clock ticking on their inheritance-dependent close-ups in Portsea (and Palm Beach)?

In summary, my message to all those born before 1 July 1962 is:  please spend (as baby boomer Colin Stephen puts it, with a visceral spit) your kids’ inheritance.  That is, spend it on anything but real-estate.  And especially, don’t financially “help” your kids to get into a late-stage bubble market in real-estate – this diverts dollars away from the real economy, and so the chances are it depresses your kids’ wages and job prospects, if not also their lives in total.  No doubt many of you privately like the idea of your kids as anxious supplicants, whether before or after your death.  If nothing else, this is presumably a psychological pay-off for the vague spectre that haunted your own outwardly-affluent childhood; that of your (now very-old or deceased) parents’ frugality demons from their own inter-war childhoods.  But if you must, property-hoard away, boomers – you can renovate your way to property nirvana and tax-less fiscal immortality, but you can’t hide from the other grim reaper.
  • NB: this post was edited and expanded at 1:45pm AEST 30 Nov 2016.

Haiku of reflection for home renovators

Once-white, mottled old
shade-cloth mirrored in pool gleams
like polished concrete

- Paul Watson


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