Can the Sandwich Generation Afford to Leave their Kids an Inheritance?

Life used to be simple. Grow up, get an inheritance or bequest from your parents when they passed on, make your mark in the world. After that, in turn, leave an inheritance to your kids to let them make their mark on the world. But with longer lifespans, the Sandwich Generation, who have to look after their elderly parents as well as young kids, have begun to question this received wisdom. So, can the Sandwich Generation afford to leave their kids an inheritance?

Will the Sandwich Generation have enough financially for an inheritance for their kids …

This is especially acute in countries like Singapore which have grown rich in a hurry. With riches come longer lives for the elderly, but also higher costs of living which the elderly, having earned third world wages for most of their lives, can ill afford in their longer retirement. As a result, the burden then falls on their children, the Sandwich Generation, to bear, while planning for their own kids as well. While the Sandwich Generation exists in other countries in the developed world, there, pensions for the older generations have allowed the younger generation to focus financially on sending their own kids to college, their own retirement and to leave an inheritance.

… or will they be spread too thinly between their own parents and kids?

To leave an inheritance or a bequest is one of the main aims of retirement, Sandwich Generation or not (see here), and it is more than just having enough money. The timing of when the bequest is made can make a lot of difference as well. With longer lifespans, leaving an inheritance upon passing on will mean that your kids only get it when they are reaching retirement themselves. And it may be a little late for them to do much more with it apart from funding their own retirement. In fact, some would argue that it makes a lot more sense to split the bequest into at least 3 parts:

• Financing a tertiary education
• Helping to pay for a home to bring up a family
• A final inheritance to help them remember you by

But for the moment, let’s look at the ways which the Sandwich Generation can leave a bequest or an inheritance for their kids.

Leaving a Bequest

What are the main ways in which someone can leave a bequest for their kids? Three come to mind:

• Investments
• Insurance
• Property

Let’s look at each of these in turn:

Using Investments to Leave a Bequest

The advantage of using investments to leave a bequest is that it grows over time, depending on the investment risks. At the very least, it can keep pace with inflation. And inflation cannot be ignored! For example, a $1 million bequest in 30 years time is worth only $500,000 in today’s dollars, if we assume inflation continues at 2% per year historically. Within the category of investments, there are 3 approaches.

1. From the same portfolio which is used for retirement

Many of us who are planning for retirement have come across the 4 percent rule. Or more appropriately a Safe Withdrawal Rate of 3% to 3.5% from investments to make sure the retirement nest egg never runs out of money in retirement. If the investment portfolio is properly managed against sequence of returns risk (see here), not only will it not run out of money over the period of retirement, but it is likely to end up with between 60% to 90% of the initial invested amount, which can be used as the inheritance for the kids.

However, this approach uses a single instrument (investment portfolio) for 2 objectives (retirement income and bequest), which means it is unlikely to do equally well at both objectives. Two disadvantages come to mind immediately:

1. The bequest can only be given as an inheritance upon passing away, instead of being available before that. However, in some cases, for example early retirement, the amount in the investment portfolio can be large enough to grow substantially over time, in excess of what is needed for the remaining years of retirement. If this happens, the excess can be given away as a bequest.
2. While we can anticipate the ending amount in the investment portfolio to be between 60% to 90% of the initial amount on average, we cannot guarantee it. So the amount of inheritance is always uncertain until the very end.

For the Sandwich Generation, however, this may be one of the only two ways to afford an inheritance for their kids. The other way being property, as we discuss below.

2. From the bequest in CPF Life

For most Singaporeans, their CPF is the main source of savings for retirement and bequests. Hence, the disappointment which many felt when they realised they will be forced to enrol in CPF Life is palpable, as it means that they will not be able to devote as much as they wish of their CPF savings to their kids, but instead have to apportion a significant portion of that for their own retirement living expenses.

Partly because of these strongly held sentiments, CPF Life now incorporates a bequest element, which is the unused portion of the amount in the Retirement Account used to enrol in CPF Life at the age of 65. Of course, this means that there are two disadvantges:

• Firstly, that there is no choice as to when the CPF member can make the bequest to his/her kids (it must be upon death),
• Secondly, it is a decreasing amount the more one ages, as shown below:

Bequest amounts for each CPF Life Scheme by age at death for males

Bequest amounts for each CPF Life Scheme by age at death for females

In light of the lifespans for men and women (at the age of 65) of 84 years and 87 years respectively, it is quite likely that the majority of the CPF members on the Standard or Escalating CPF Life Plans will not be able to leave a bequest for their kids upon their passing. While there is a better chance for those on the CPF Life Basic Plan to do so, it is likely that they will only be able to leave a third of the initial amount as a bequest. Furthermore, they will have to trade-off for a lower standard of living in their retirement years as well.

3. From a dedicated investment portfolio

Of course, the best way to ensure flexibility and certainty in making a bequest or inheritance for the kids is by way of a dedicated investment portfolio. But this is also the most expensive way of doing so. It requires keeping aside a portfolio of your assets which cannot be touched for other purposes.

For example, $100,000 can invested in a low risk global bond fund which pays about 4% each year. Even without re-investing the payouts, this amount can be expected to grow to $140,000 in 10 years. Or $180,000 in 20 years. And to $220,000 in 30 years, all the while retaining the flexibility of being able to be used whenever the kids need it.

This can be further enhanced if you have access to leverage. Suppose instead of just investing the $100,000 in the bond fund, you use a secured overdraft to borrow another $100,000 to invest in the same fund, paying, say SIBOR + 150 bps, or 2% a year for this.

	Initial investment	Borrowed through overdraft
Invested amount	$100,000	$100,000
Yearly payout	$4,000	$4,000
Interest cost	$0	$2,000
Yearly gain	$4,000	$2,000

Given the assumptions made, this initial $100,000 set aside for the bequest will grow by 6% every year. Even without re-investment, it can be expected to grow to $160,000 after 10 years. Or to $220,000 after 20 years, and to $280,000 after 30 years!

Using Property to Leave a Bequest

Using property to leave an inheritance is usually the default method of doing so. At least it is so in Singapore, where home ownership rates are high. Stories of parents buying a freehold semi-detached house for $35,000 back in the 1970s, and leaving it for their kids in 2020 when it is worth $3.5 million fire our imagination of what property can do for our kids!

But with the days of high GDP growth and population growth likely behind us, such massive monetary gains from using property to leave an inheritance may not be possible anymore. Despite this, the real value of property as an inheritance, i.e. having a roof over our heads, remains unchanged. However, this is strictly only true for freehold property. As the majority of residential property owned in Singapore is on 99-year leaseholds, using property for an inheritance has its drawbacks.

A. Using private 99-year leasehold property

Since 99-year leasehold property reverts back to the State after 99 years, it means that its value falls to zero after 99 years. Much confusion has reigned on this issue after the theoretical relationship between freehold and leasehold prices in Singapore, or Bala’s curve (which we analyse here) has come to light, as we show below.

Leasehold decay curves – Bala’s table and others

But as we show here, Bala’s table and other leasehold decay models do not mean that the value of 99-year leasehold property will fall continuously from day 1. In fact, as predicted by Bala’s table (see chart below), and borne out by market price evidence, 99-year leasehold property will continue to rise in value for 50 to 60 years before finally falling in value to zero.

How prices of 99-year leasehold property rise over time, before falling

Hence, there is still value in using leasehold property for a bequest for our kids. The problem with this is of course we may not be able choose when we pass it on to our kids (especially if we still need to live in it). And we also cannot guarantee the monetary value of what we bequest (although the real value is the same).

B. Using a HDB flat

For many Singaporeans, their HDB flat will be the biggest asset they own in their lives. It will also form the most significant bequest or inheritance for their kids. Which means that unless they have bought a pretty old HDB flat to begin with, there is little danger of having nothing to leave to their kids, since the dynamics of HDB flat prices work in pretty much the same way as 99-year leasehold private property. As a result, the HDB flat will continue to gain in value over time until about 50 to 60 years into its lease, before slowly decaying.

But HDB flat owners have a second ace up their sleeve when it comes to making a bequest for their kids. This is the HDB Lease Buyback Scheme (LBS). LBS, while unfairly disliked, actually allows elderly HDB homeowners to sell back the tail end of their lease back to the HDB at a fixed future price, as we show here and below.

Lease Buyback Scheme – selling the tail end of the lease for a fixed price now

In this example, an elderly couple who own a 35 year old HDB flat worth $520,000 can sell back the last 35 years of their lease to the HDB at a price of $759,000 in 30 years time. What they actually receive right now is the discounted value of $759,000, or $219,300 in their CPF Retirement Account. But this amount, at the interest rate of 4%, will grow to $759,000 in 30 years time!

The monetisation of the HDB flat really gives HDB flat owners a lot of flexibility in making a bequest for their kids. If they have already met their CPF minimum sum and enrolled in CPF Life, they can withdraw the amount from the Lease Buyback Scheme anytime from their Retirement Accounts, to make a bequest to their kids. Or they can simply let it grow in the Retirement Account to a much larger sum. So, surprisingly, using an HDB flat for a bequest gives the owners more flexibility compared to a private apartment.

Using Insurance for leaving a Bequest

While the layman might think of life insurance for their protection needs only, insurance companies see themselves as wealth managers as well. Hence many life insurance products such as Whole Life Insurance, or Investment Linked Policies (ILPs), and Endowment Policies can serve as a form of investment as well. Which means that they can be used to leave a bequest or inheritance. Term life insurance can also be used, as they provide a payout upon the passing of the insured.

I. Using Whole Life Insurance

The term Whole Life is used generically here, to cover a whole spectrum of life insurance, including whole life policies, investment-linked policies, endowment polices. That is, any life insurance policy which builds cash value over time. They can come in the form where a single premium is paid, or an recurring premium is paid, or even where the premium is only paid for a fixed number of years. While we may buy such life insurance policies for the purpose of insuring our lives, or building a fund towards the purchase of something in the future, they can be easily repurposed towards setting up an inheritance as well.

In the simplest case, the insurance policy will pay out upon the passing of the person whose life is insured, i.e. the parent, providing an inheritance. However, insurance policies can build up cash value over time. And they can also be surrendered at any point even before the passing of the parent to provide a bequest. In this sense, they are similar to the use of a dedicated investment portfolio to generate the bequest or inheritance. But, being a multi-purpose instrument (i.e. for insurance and for investment), the returns may not be as high as a well managed, dedicated investment portfolio (see here).

Also, unlike a dedicated investment portfolio, as long as premiums are still payable on the life insurance policy, leverage is usually not available to boost the returns. The simple solution to this is of course to surrender the policy and put it into a single premium policy, which can then be used as collateral or security for an overdraft. In short, the use of whole life insurance to leave a bequest or inheritance is very similar to the use of a dedicated investment portfolio.

II. Using Term Life Insurance

Term Life Insurance can also be used to provide an inheritance (see here). The insurance policy pays out upon the passing of the parent, and hence while the timing of the inheritance cannot be certain, and there is no flexibility of providing an earlier bequest, the amount of the inheritance is certain.

Because of the rather anomalous pricing of term life insurance to 99 years of age, buying such a policy at the age of 50 and above has a positive net present value! Of course this is set against the likelihood of not being insurable as we age (e.g. due to health reasons). Surprisingly, the net present value of buying Term Life Insurance at the ages of 50, 55 and 60 (if still insurable) are comparable, even after accounting for the opportunity costs of the premiums paid. This means the higher premiums (see below) are offset by the shortening of the time to getting the payout!

$500K coverage to age 99	Premium Age 50	Premium Age 55	Premium Age 60
Insurer A	$5,567	$7,125	$8,527
Insurer B	$6,060	$8,930	$12,670
Insurer C	$5,466	$7,469	$11,111
Insurer D	$6,391	$8,503	$11,770

*See here for an update on using life insurance for a bequest!

Which is the best way to leave a bequest or inheritance for our kids?

So, there seems to be no shortage of ways for the Sandwich Generation to leave an inheritance or a bequest for our kids. It only costs money! But there are cheaper ways, and more expensive ways, and each way has its pros and cons.

Pros and cons of each way of providing a bequest

	Addition Money needed?	Certainty of amount?	Flexibility in timing?
Retirement Portfolio	N	N	N
CPF Life	N	Y / Decreases	N
Investment Portfolio	Y / Lots!	Y / Somewhat	Y
Private Property	N	N	N
HDB Flat	N	Y	Y
Whole Life Insurance	Y / Lots!	Y / Somewhat	Y
Term Life Insurance	Y / Moderate	Y	N

As we can see above, the trade-offs are really between how much more money is needed to provide for the bequest, and how flexible the timing of the bequest can be. Interestingly, an HDB flat may be the best vehicle for passing on wealth, thanks to the ability to monetise the value through the Lease Buyback Scheme.

But what is also true is that personal finance is a complex matter. It is usually not the case where there is one alternative which is superior to every other choice. Rather it is about product allocation, using a combination of products to meet your objectives, which is key.

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