The bank of Mum and Dad: your questions answered

The bank of Mum and Dad is often referred to by parents, children and various media outlets as another means to purchase property for the next generation.  The cost of living crisis which has followed the surge in the property market over recent years has made it increasingly more difficult for the next generation to get their feet on the property ladder.  This article outlines the different ways parents may structure lifetime provision for their children and, whilst it is not an extensive overview, it provides food for thought for those considering supporting their children.

When and how should you loan money to your children?

Loans are quite often the default parents consider when making provision, as it allows the money to be recalled during the parents’ lifetime, therefore providing a protective element.  Loan agreements should be documented in writing making it clear the terms of the loan i.e. when it is to be repaid.

Parents should give thought as to whether they realistically expect the loan to be repaid during their lifetimes and, if not, how those loans are to be dealt with on their death.  If the loans are to be forgiven on death and brought into account with equalising your estate between all of your children, this should be dealt with specifically in your will.

Please note, by making a loan, the value of the loan is still an asset of your estate for inheritance tax (IHT) purposes, as opposed to making an outright gift, where there is an IHT benefit to be had.

What is the best way to make outright gifts to your children?

For parents who are comfortable with not retaining control of the money by virtue of a loan, they could consider making a lifetime gift.  Bear in mind that once a gift is given, it cannot be recalled, so care should be taken to ensure you do not give away more than you can afford, both now and in the future.

By making an outright gift, the money becomes an asset of your child(ren)’s estate for their own IHT purposes and it would pass under the terms of their will(s) on death, which could see their beneficiaries being in receipt of your money (who you would not have chosen yourself).  It is also in their estate for divorce and bankruptcy purposes.

There is no limit under the current IHT rules about how much you can give away during your lifetime.  The rules are briefly set out below, but specialist advice should be sought if you have further queries, as the below is not an extensive overview:

•    Exempt transfers are gifts which are wholly exempt from IHT (e.g. within the annual exemption, currently £3,000 per tax year); and
•    Potentially exempt transfers (PETs) are outright gifts between individuals and, following the 2006 Finance Act, gifts into trusts for the disabled.  A PET does not give rise to an immediate charge to IHT.  If the donor survives for 7 years, the PET becomes an exempt transfer.  If the donor dies within 7 years of the gift, the PET becomes a chargeable transfer. There is a sliding scale of taper relief which applies in the case of a PET or a chargeable transfer made less than 7 but more than 3 years before death; in such a case the tax charged on death on the PET or chargeable transfer is reduced by 20%, 40%, 60% or 80%, according to whether the death occurs in the fourth, fifth, sixth or seventh years respectively.  Since taper relief reduces the tax charged on death and not the value of the gift, the tax on the donor’s remaining estate is unaffected and the taper relief will be worthless if the PET or chargeable transfer falls within the donor’s nil rate band. In the case of a lifetime gift, the amount on which IHT is charged is measured by the loss to the donor’s estate as a result of the gift.

Therefore, there is a benefit to be had by making a gift where the gift is over £325,000 if you survive at least 3 years before death.

What are the advantages of setting up a trust for your children?

For those not comfortable with making an outright gift, provision could be made for your children through a trust structure.  Transfers to a trust during your lifetime as referred to as a chargeable lifetime transfer (CLT).  Chargeable transfers are gifts made by an individual other than exempt transfers or PETs.  This category covers a gift to most types of trust. If the cumulative total of chargeable transfers in any 7 year period exceeds the nil rate band threshold (currently £325,000), a lifetime transfer is immediately taxable of 20%.

Provision for your children through a trust structure can be beneficial where you want to remain in control of the money, by being the trustees of the trust and provide a protective framework within which your child can benefit.  Please note, where your children are minors, there are specialist rules that need to be considered before putting in place a trust.  Please note, trusts are subject to their own IHT regime and the rules regarding this falls outside the scope of this article.

What to think about if purchasing a property for your children to live in

For those parents who would rather retain in control of the assets but are not comfortable with using a trust structure, you could consider purchasing a property in your name(s) for your child(ren) to live in.  The upside of doing this is that you retain control of the asset whilst having the benefit of seeing your child(ren) have their own home, albeit they do not own the underlying capital.  However, the downsides to this option are (but not limited to) the following:-

•    The higher rate of stamp duty land tax may apply on the purchase, if you own another home;
•    You may be subject to capital gains tax on future sale, if you do not occupy the property as your main residence;
•    Any increase in value in the property will be in your estate for IHT; and
•    You will need to consider updating your will to allow your child to continue living in the property after your death, or to receive a legacy of the property itself.

Making the decision to not leave provisions for children

There are, of course, some parents who believe anything their children receive is a bonus and do not agree with making provision for their children during their lifetime.  It is not unusual for the next generation to include potential assets they may inherit when considering their own estates, despite their parent(s) potential need for future care which could absorb all of their parents’ assets.  For any children reading this article, bear in mind, there is no guarantee your parents’ wills make financial provision for you, so inheriting should not be seen as a guarantee when considering your own estate.

There is no right or wrong answer when considering your children’s’ needs and, whilst it is difficult for the next generation with the cost of living and inflated house prices, it will no doubt be even harder for current or future generations.  Despite the doom and gloom of what the future holds, it is imperative that whichever route you choose to make provision (if at all), your own estate planning documents are drafted in such a way to ensure not only any gifts / loans are dealt with correctly on death (and potentially equalised with any other children you may have) but sufficient provision is made to allow your child(ren) to continue living in the property / properties that you have brought for them after your death and therefore specialist advice should be sought.

If you have any questions about this topic, please get in touch info@ts-p.co.uk