Adult children are increasingly banking on the financial support of their parents, but older generations must not lose sight of their own needs.
If only all banks were as charitable as the Bank of Mum and Dad.
Parents and grandparents handed over nearly £9bn to younger generations last year, helping them onto the property ladder, and funding them through university.
And according to Legal and General, less than a quarter want to be reimbursed.
But while all loving parents strive to support their offspring - especially with the wave of financial challenges facing younger people right now - they must avoid jeopardising their own financial future in the process.
If you’re in this situation and are unsure how to strike the right balance between your children’s needs and yours, here are five crucial questions to ask.
1. Should I gift or loan?
Whether it’s best to loan or gift money to your children is entirely up to you – there's no right or wrong approach here.
It’s about working out the right way to support the broader needs of the family unit.
Naturally, I’m sure you’d prefer to make an outright gift.
However, if helping your children will plunge you into financial hardship down the line, then a loan agreement might be more suitable.
The key is for all parties to be clear about how the arrangement works.
If you do decide a loan is best, this might mean drawing up a contract, which although could make for an uncomfortable conversation, can avoid problems and disagreements down the line.
2. Will I have to pay tax?
Gifting money to your children can be a great way to save tax, most notably inheritance tax. But in some situations, you might still end up with a hefty tax bill from HMRC.
Here are the key taxes to keep in mind.
If the gift is below £3,000 for the tax year in question (you can also carry forward last year’s allowance if unused) or it is made from normal expenditure, then it will typically escape IHT.
You can also gift £5,000 towards a wedding if you’re a parent, or £2,500 if you’re a grandparent.
Anything else is treated as a potentially exempt transfer, which means the gift moves outside of your estate if you survive seven years from the date it was made.
If you were to die within this period, the gift would be dragged back into your estate for IHT purposes.
For gifts that exceed the current IHT threshold of £325,000, a taper applies.
After three years, the amount of IHT due reduces proportionately every year, disappearing completely after year seven.
Extra care must be taken when transferring a property that you want to continue living in.
In this scenario, you must pay the new owner a market rent, otherwise it will be treated as what’s called a ‘gift with reservation of benefit’ and remain as part of your estate.
Some assets, such as a business or a portfolio of AIM shares, might attract business property relief, meaning they can be passed down free from IHT or at a reduced rate.
However, it’s worth seeking professional advice here to make sure you are doing the right thing as often it's more prudent to retain assets that are IHT exempt, and gift those that don't attract relief.
Capital gains tax (CGT)
If you’re planning to transfer a property, business, or portfolio of shares, it's important to be aware of the CGT implications.
Any transfer or gift is treated as a normal sale. So, if the gift is worth more than what you paid for it, you could face a CGT bill of up to 28 per cent.
For the 2023/24 tax year, you can realise a profit of £6,000 without paying CGT due to the annual exemption. This allowance is falling to £3,000 from 6 April 2024.
If you make a one-off withdrawal from your pension pot to hand to your children, you might be hit with an income tax bill.
While up to 25 per cent of your total pensions can be drawn tax free, the rest is taxed as income at your marginal rate.
In other words, the top rate of tax you pay, which could be as much as 45 per cent.
However, your children will not pay any income tax on receipt of the funds.
3. What if I’m asset rich but cash poor?
You don’t necessarily need bulky savings and investment accounts to help your children financially. Unlocking the value within your home presents a further option.
According to a recent study, around one in five over 50s are considering using the equity in their home to help younger relatives.
With equity release, you take out a lifetime mortgage on your home and pay it back either when you die or move into long-term care.
You are free to use the lump sum as you please, including gifting it to your children.
But despite the growing appeal of equity release, the product isn’t for everyone. It is more expensive than a conventional mortgage.
An alternative is a guarantor mortgage. This is where you agree to take on your child’s mortgage repayments if they can no longer afford them.
This often involves using your own home as collateral.
The benefit here is that your child can secure a home with a smaller deposit, making homeownership a reality sooner.
The downside is that you’re on the hook should things go wrong.
Using the family home to support your children isn’t a decision to be taken lightly.
It’s therefore important to seek expert advice from a regulated mortgage broker or specialist equity release adviser.
4. How can I protect my wishes?
If you’re nervous about making outright gifts, you’re certainly not alone.
You might be concerned that the money will end up in the wrong hands.
For example, you give your child £50k buy their first home. A few years later they get married, but it ends up in divorce. Unless you took steps to protect this gift, £25k might pass to your child’s ex-partner as part of the settlement, and importantly disappear from the family unit.
Fortunately, this situation can be avoided. The key is to take preventive measures at the point of gifting.
A legal document such as a deed of trust can ensure that the money remains in your immediately family, whatever happens in the future.
As legal documents are typically complex, it’s wise to speak with a solicitor who specialises in family law to make sure it is completed correctly and in-line with your specific wishes.
5. How can I ensure any gift is affordable?
You may feel that a gift is affordable right now, but have you considered how it might affect your finances down the line?
This is where cashflow modelling comes in.
In its simplest form, cashflow modelling is a tool used by financial advisers to provide a roadmap of your financial future.
You supply a detailed picture of your assets, liabilities, income, and expenses, and these are projected forward to gauge how your finances might look in, say, 10 to 20 years’ time.
Cashflow modelling can offer you the peace of mind that anything you pass to your children will not compromise your own financial stability.
Your financial adviser can test different scenarios to ensure that the decision you take is affordable both now and in years to come.
When gifting or loaning money to younger relatives, it’s crucial to seek expert advice from a qualified financial adviser, particularly one who specialises in intergenerational wealth planning.
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