Making that windfall last

One in five people who receives an inheritance of $100,000 or more spends the lot, rather than saving or investing at least some of the money, according to a US study that probably reflects what happens in Australia, too.

The average person saves only half what they receive, according to the just-published Ohio State University study. In the US, that would mean anything up to $US2 trillion ($1.9 trillion) of the $US4 trillion expected to be handed down in the next decade could be frittered away on ''discretionary'' spending such as cars, TVs and holidays.

In Australia, the figure would be in the billions, with $400 billion in real estate alone expected to pass to baby boomers from parents now in their 80s.

''It's frightening to think people could be inheriting a significant amount of wealth and not putting some sort of strategy around it,'' the managing director of ipac financial care, Brendan Burwood, says.

With superannuation balances looking thin, and the prospect of government subsidies for aged care having to be reduced, Australians would be much better off putting most of an inheritance away, he says.

''You wouldn't want to have some great regret down the track,'' Burwood says. ''You don't want to be thinking 20 years from now, 'I could have made things a lot easier for myself simply by not taking that round-the-world trip.'''

Worse, some baby boomers spend money coming in an inheritance only to discover the final sum is smaller than expected because of tax and the way the inheritance affects their age pension.

The US study found one-third of beneficiaries, at best, experienced no change in their wealth and, at worst, a decline after getting an inheritance. Burwood says there are two camps when it comes to inheritances: those who view the money as a legacy and those who view it as they would a lottery win.

He tends to see people who fall into the first camp, who might have sought help for the parents with regard to the intricacies of aged-care funding and then return for ideas on what to do with an inheritance.

These people tend to acknowledge that their windfall has come from a lifetime of hard work by their parents and therefore feel a responsibility to use it wisely.

He's aware of the other camp because the first group will share tales of siblings who are frittering money away, or because people seek professional help to fix mistakes they've made with an inheritance.

The principal of Multiforte Financial Services, Kate McCallum, knows the fight between heart and head when there's an inheritance, but also sees a divide based on how much has been bequeathed.

''What I've observed is when it's a big cheque - $1 million or more - people definitely see it as a legacy,'' she says. ''There's an understanding that they have to protect this, they have to look after what somebody else has built up. There's a real sense that it's to be passed on [to future generations].'' With smaller sums, there's a more pragmatic approach - paying off the mortgage and boosting super, for a start.

Burwood's advice is that when you receive an inheritance, the first thing you should do is pause.

''There's no technical reason why you need to do anything immediately,'' he says. ''That's the good news because you can sit for a minute and reflect.''

''Where we've seen clients go wrong is when they've rushed and taken action without any real decision-making framework.''

Start by considering any tax implications should you liquidate assets. Generally, you have up to two years to dispose of the family home before capital gains tax applies but other assets, such as investment property or shares, will need to be looked at.

''Understanding the CGT repercussions is really critical,'' Burwood says. ''Knowing what to keep and when to sell can make a massive difference in what you're actually going to receive in the hand.''

Next, look at the potential effect on your age-pension entitlements. The assets received from the deceased estate are now yours, so they count towards the Centrelink income and assets tests, which potentially can be ''disruptive'', Burwood says. ''People are very anxious these days about their pension entitlements - and rightly so, when they're not receiving a lot of interest from their term deposits.

''But it's not doom and gloom - it's just that the configuration of how you're receiving income is going to change, with the pension carrying less of the load.''

Then have a financial health check. Could the inheritance be used to pay off credit cards and other debt? Could it help pay for better insurance cover? Could it provide the emergency fund you've never had? (Burwood suggests having at least three months' expenses set aside.)

McCallum says super can be an excellent destination.

While there's a $25,000 limit on ''concessional'' contributions to super from your pre-tax salary, you can still make $150,000 in ''non-concessional'' contributions annually from money such as an inheritance.

Non-concessional contributions don't have the benefit of lowering your salary and therefore your income tax but they still benefit from the attractive 15 per cent tax on earnings within super, or zero tax once you're in the pension phase.

Paying off your mortgage is another no-brainer, saving a big chunk of interest in the long term and freeing up funds for other productive uses.

''Think of it as a risk-free return,'' Burwood says of the benefit of clearing this debt. ''It's difficult to achieve the same after-tax return on your investments as the amount you can save on interest.''

You might like to think of helping others with your inheritance. ''If your own financial situation is relatively secure, you might want to help ease the financial pressures on your children and their families,'' Burwood says. You could also help a charity (see story, left).

Finally, having covered all the bases, you might like to indulge yourself.

''We're not saying don't give yourself a treat or do something just to make life more enjoyable,'' Burwood says. ''Absolutely, that should be on the list, too.

''Maybe put away 5 to 10 per cent just for doing something you've always dreamt of doing - that's fair enough.

''All we're asking people to do is have a framework for decision-making. If you still say, 'I want to spend X dollars on this,' at least you've thought it through.''

Key points

❏ There are two types of inheritors: some see it as a legacy, while some see it as a lottery win.

❏ The 'lottery winners' tend to spend the inheritance with little thought for the future.

❏ Others apply it to the mortgage, superannuation and investments.

❏ Understanding the tax and pension implications of an inheritance is critical.

❏ Set aside 5 per cent to 10 per cent for some fun.

What's fair?

Lawyer Donal Griffin acted for an elderly widow with two daughters. One had given far more support than the other, but their mother did not want to be seen to prefer one over the other in her will.

"When I asked about her grandchildren, she said the favourite daughter had three kids but the other daughter had one," says Griffin, of de Groots Wills and Estates Lawyers.

He suggested she divide her estate into three pots: one for each daughter and one for the grandchildren. The result was that each member of her family was treated the same as the equivalent family member on their level, but by weight of numbers, more of her wealth would pass to the side of the family that had looked after her as she had got older.

Griffin says that when it comes to inheritances, people expect to be treated "fairly". But "fairly" is not a legal definition and does not necessarily mean "equally". In fact, there is nothing to stop someone challenging an equal share on the grounds they have not been adequately provided for.

"There have been hundreds of cases in the last decade alone trying to establish what level of provision is appropriate in the circumstances," Griffin says. "The law requires that these cases be decided on their own facts, so thousands of dollars are spent by people giving their side of a family dispute."

In his experience, though, it is not so much a perceived lack of fairness that leads to disputes but, rather, surprises.

"A totally non-legalistic way to avoid disputes is to ensure that beneficiaries have had a chance to get used to the proposed distribution," Griffin says.

So perhaps this Christmas, when the family is together and before too much Christmas cheer is imbibed, parents can take the time to explain in broad terms how they plan to deal with their estate.

Later, it will be harder for a child to say they did not have a chance to stake their claim.

'Tis better to give ...

The vast majority of Australians settle for the default option of leaving everything to the kids, but you don't have to be wealthy or childless to leave a bequest to charity, and it's not a complicated process.

The director of the NeuRA Foundation, Roewen Wishart, has been involved with bequests for many years as the head of a body established to fund the work of the Neuroscience Research Foundation, which focuses on brain diseases such as Alzheimer's and Parkinson's.

Wishart says that while one-third of Australians say they would be willing to leave a gift to charity once family and friends were provided for, most don't end up doing so. Yet it's as simple as including a line in your will that says something such as: "I give one-third of my estate to my daughter and the remainder in equal parts to these three charities."

He says it's a fallacy that only wealthy people leave money to charity. "The reality is that most bequests are made by people who've lived ordinary lives," he says. "A bequest is a way of them making an extraordinary gift - something larger than they'd have been able to make in their lifetime."

A Swinburne University of Technology study that looked through 1800 Victorian probate files found that just 5 per cent of these estates included a charitable bequest. This contrasts with the 87 per cent of Australians who give something to charity each year while alive.

"Most leave everything to family, and, more specifically, to the children," study author Christopher Baker writes. "This seems to occur irrespective of need."

For example, a Melbourne widow aged 91 left an estate of $10 million to her three children, aged 71, 69 and 65. "The executor of the will was the son, a retired barrister from a very wealthy suburb," Baker says, though the circumstances of the two daughters were not addressed in the file.

"How an individual distributes their estate is, of course, a matter of personal choice. Nevertheless, in this example, had the woman left 1 per cent of her estate as a charitable bequest, the resultant $100,000 could have been of considerable benefit for the charity or charities concerned and the impact on the children's share would have been negligible," says Baker, a research fellow at the Asia-Pacific Centre for Social Investment and Philanthropy at Swinburne. "Had she left 10 per cent of the estate as a charitable bequest, the benefit to the included charities would have been tenfold and the share left to each of the children would have been reduced from approximately $3.3 million each to $3 million."

A disheartening trend is for challenges to be made to charitable bequests. "Australian charities, particularly over the last 10 years, have become more familiar with people exercising their rights to challenge the provision made for them in a will,'' Wishart says.

"Most charities tend to have the approach that the wishes of a person who has left the gift should be honoured, but they acknowledge that the parliaments have provided the means by which people with a genuine need or genuine moral claim can seek to review what someone did in their will.

"That can be a drawn-out process for everybody concerned, and I think charities try to seek a proper balance between defending the wishes of the person who has passed away and being sensitive to the individual situations of people who are in need and have a moral claim."

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