Some of us are brought up to believe that leaving a big legacy to our children is a Good Thing. After all, doesn’t it demonstrate how financially successful we’ve been during our lives? Well, perhaps, provided we haven’t had to be miserly, turn off the central heating in winter, and never go out! But seriously, for some of us, spending the kids’ inheritance just doesn’t feel right. It may be important to us that we make our children’s lives more secure after we’re gone. Should we do that by ring-fencing certain assets for them? That could work provided our remaining assets are sufficient to support our lifestyle for the whole of our retirement, with little or no risk.
Ring-fencing assets may not be the right approach for most people who wish to leave a legacy. After ring-fencing, the remaining assets may not be enough to generate an adequate fixed income. We may not have a defined benefit pension to help prevent us from exhausting our funds. We don’t know exactly how long we’ll live. It’s almost impossible to exactly spend our savings before we die. If we don’t want to risk running out of money, we’re very likely to leave something from our non-ring-fenced assets, whether we want to or not!
Example 1: Ring-Fence The House
As an example, suppose I live in a house worth £250,000, and I have a total of £500,000 of assets when I retire. Then, if I want to ring-fence the house to leave to my children, I need to generate an income for life from £500,000. Annuity rates are at historic lows. Provided I’m not totally risk-averse, I may decide to invest in the market. I could go for a combination of income and growth, and adopt a drawdown strategy. Unlike an annuity, this will give me a low, but not a zero, probability of running out of money at some point. I would still want to keep lifetime risk within acceptable bounds. So I may need to limit my annual drawdowns to a relatively low percentage of my invested assets.
Example 2: Equity Release
However, suppose I don’t ring-fence my house. Then I’ll have an additional financial cushion. I can most likely release equity from my home in an emergency. This would not be a desirable outcome, since it would reduce the value of my legacy. But it does allow me to drawdown somewhat more from my investments. My lifetime risk is reasonably low, since equity release is a fallback option. The risk of having to release equity from my home will be higher than the risk of my completely running out of money. But it will still be relatively low. But whereas completely running out of money is a disaster, releasing home equity is not. It’s just undesirable. It’s may be more likely that I won’t have had to release equity before I die. In this case I’ll be able to leave the house plus cash.
So rather than ring-fencing the house, I may find it perfectly acceptable to have a high probability of being able to leave the house debt-free when I die, if that gives me a better standard of living in retirement.
Practical Steps
Spending the Kids’ inheritance may or may not be your intention. Either way, our calculator can assist you. Using it, you can (if you really want) ring-fence assets by including the value in the contingency fund. But by not ring-fencing, you’ll allow the tool to come up with a strategy that balances probabilities. It takes account of your stated risk aversion and desire to leave a legacy.