The great intergenerational wealth transfer explained

By Gary Anders

In what has been widely referred to as the “great wealth transfer”, about US$68 trillion (A$100.2 trillion) in assets worldwide is expected to shift from the estates of deceased “baby boomers” – people born between 1946 and 1964 – to their heirs in the next 20-30 years. This is expected to be the largest intergenerational wealth transfer in history.

A research paper released by the Productivity Commission in late 2021 notes that about A$3.5 trillion in assets will likely change hands in Australia alone by 2050.

This will mostly be in the form of residential property, unspent superannuation funds and other investment assets bequeathed to family beneficiaries.

Inherited assets currently total about A$120 billion per year in Australia, and this figure is expected to quadruple to almost A$500 billion per year over the next 25 years.

The large increase reflects the expectation that property values will increase significantly over the longer term, as they have in the past.

Impact assessment

The transfer of accumulated wealth from one generation to the next is nothing new – it has been the norm throughout human history.

However, will the record transfer of wealth that is destined to take place over the next few decades differ from past ones? Sheer volume and value suggest it will.

A study by research group Cerulli Associates estimates that a massive US$84.4 trillion (A$128 trillion) of personal wealth will be transferred in the US by 2045. This will comprise US$72.6 trillion (A$110 trillion) in assets being shifted to heirs and a further US$11.9 trillion (A$18 trillion) in charitable donations.

For researchers and economists, the bigger question is whether the impending wealth transfer will have a greater economic and social impact across generations than previous wealth transfers. If it does, could it exacerbate wealth inequality?

The challenge for governments across the globe will be to tackle wealth inequality and capitalise on opportunities to raise revenue via taxes.

Opinions are divided on this subject. For one thing, wealth transfers tend to have less of an impact on inequality in most wealthier countries – which have high living standards and strong welfare systems – than they do in poorer nations.

The Productivity Commission has found that while inheritances and gifts in Australia have more than doubled since 2002, wealth transfers are reducing some measures of relative wealth inequality.

 

"If you’re in the bottom fifth of the wealth distribution, your average equivalised wealth is about A$7200, but your inheritance on average is about A$3500. These inheritances are really life-changing in the bottom fifth of the wealth distribution."

 

Catherine de Fontenay, commissioner at the Productivity Commission, says it is not hard to see why this is the case when examining the share of total wealth held across the population.

“If you’re in the bottom fifth of the wealth distribution, your average equivalised wealth is about A$7200, but your inheritance on average is about A$3500,” de Fontenay says.

“These inheritances are really life-changing in the bottom fifth of the wealth distribution.

“In the top quintile, your average wealth is about A$1.3 million in equivalised terms, and your average inheritance is about A$121,000,” de Fontenay explains.

In Australia, people tend to inherit at an average age of 50. At that point, at the top end of wealth/income, heirs have often already accumulated significant wealth, says de Fontenay, so the inheritance may be small in relation to their existing wealth.

“Obviously, there is variation in there, but the broad point is that you’ve already accumulated quite a lot of wealth at that stage,” she says.

Asset price growth – particularly for housing – has a much greater impact on wealth inequality between the property haves and have-nots than inheritances do, says de Fontenay.

The Productivity Commission study shows that each generation has been wealthier on average than the previous one at the equivalent age, but baby boomers have done particularly well.

The study also examines intergenerational wealth persistence – how much an individual’s wealth resembles the wealth of their parents and the role that inheritance plays in that.

In Australia, says de Fontenay, only about one-third of the correlation between an individual’s wealth and their parent’s wealth is due to inheritances.

“A lot of the persistence comes from the advantages that they give you early in life, so things like giving you a great education, giving you certain cultural attributes and giving you networks,” she says.

However, because most people gain inheritances late in life, this limits the impact they can have on opening up different life choices and opportunities about career and family, thereby making it more unlikely that inheritances drive the correlation between wealth from one generation to the next, says de Fontenay.

“The average financial gift is about A$8000 and the median is about A$1000. If we look at gifts that are probably related to buying a house and gifts for people that are aged 25 and over, the average amount is about A$15,000 given over three years.

“In the top quintile, it averages about A$25,000 over three years. The takeaway is that most of the larger gifts are going to wealthier individuals, but those wealthier individuals already have wealth,” de Fontenay says.

Government approaches

Policy approaches taken by governments and tax authorities tend to greatly affect either the reduction or increase in wealth inequality.

There are also differing schools of thought on how governments should approach inheritance in general, especially in terms of so-called “death taxes” that are designed to capture revenue when accumulated assets are passed on to beneficiaries.

There are no formal inheritance or wealth taxes in Australia as such, although taxes can apply to certain asset transfers, and high-income earners do generally pay tax at the top marginal tax rate.

An owner-occupied family home can be inherited in Australia without capital gains tax (CGT) consequences, providing it has not been used to produce income at any time and is sold within two years.

However, CGT will apply to some assets, such as an investment property inherited from a deceased estate, and income tax will apply on any dividends or rental income from inherited shares or property.

 

"Everything that was subject to CGT in the hands of the deceased is subject to a capital gains tax event at death. The CGT clock starts ticking again at that point, and tax can be payable again when the asset is sold and leaves the estate."

 

Richard Webb, policy adviser in financial planning and superannuation at CPA Australia, says, “Everything that was subject to CGT in the hands of the deceased is subject to a capital gains tax event at death. The CGT clock starts ticking again at that point, and tax can be payable again when the asset is sold and leaves the estate”.

The other main issue for non-dependant beneficiaries such as adult children is inherited superannuation from a parent, Webb says.

Dependants such as a spouse and minors are exempt from paying tax on inherited superannuation. However, non-dependant children aged 18 years or older are typically not, unless they fit certain criteria. 

Inheritance taxes are already in place in many countries, such as the UK and in various US states.

The US Government also applies estate taxes on a sliding scale ranging from 18 per cent to 40 per cent on personal assets valued at over US$12.92 million (A$19.6 million).

In the UK, a 40 per cent inheritance tax is applied on assets valued at £325,000 (A$594,500) or more, but no tax is applied if assets are left to a spouse, a charity or a community sports club.

The inheritance tax threshold is increased to £500,000 (A$915,000) if a home is left to one’s children or grandchildren.

India abolished its wealth tax in 2016 but now imposes a 12 per cent “super rich” income surcharge on individuals earning above ₹10 million per year (A$185,000).

In response to COVID-19’s rapid spread, the Malaysian Government enabled individuals to make up to four withdrawals from their retirement savings to offset the pandemic’s financial impact. Many individuals fully depleted their accounts, and the country is now facing a retirement savings crisis.

Dr Kim Leng Yeah, professor of economics at Sunway University, says that Malaysia’s other serious problem is increased wealth and income inequality.

Yeah is also one of the five members of a special body set up to advise Prime Minister Datuk Seri Anwar Ibrahim in his capacity as finance minister, and says Malaysia’s income inequality has risen in recent years, especially following the pandemic.

“The growing gap between the rich and the poor has, in a way, prompted the government to look at how they can tax the intergenerational transfer of wealth, especially for the very rich,” Yeah says.

“They have accumulated much wealth, and during the transfer of wealth to the next generation there would be an opportunity to diversify the Malaysian Government’s revenue.

“They’re taking lessons from other countries in terms of the difficulties of implementing intergenerational wealth tax.”

In the years ahead, if the disparity continues to widen, there could be a case to enhance Malaysia’s tax revenue by imposing some kind of a wealth transfer tax, says Yeah.

“The ageing population would also require the country to look into how the future wealth transfer will occur and to what extent some kind of mechanism is necessary to redistribute wealth and create a more equal society,” Yeah explains.

Yeah says the Malaysian Government will need to tread carefully when it comes to imposing wealth and inheritance taxes.

“Intergenerational wealth tax or inheritance tax could result in more aggressive tax planning – that’s the problem when the government is talking about imposing inheritance taxes on the super rich,” Yeah says.