How to be the Bank of Mum and Dad
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The so-called Bank of Mum and Dad (Bomad) has never been busier.
In 2020, gifts from parents, grandparents, friends and relatives were behind more than half of house purchases among the under-35s, according to a study by Legal & General — and this pattern of lending is expected to continue.
Rishi Sunak’s Budget announcement of a stamp duty holiday extension “will only serve to energise [those buying with the help of Bomad] to keep trying to secure a property before June”, says Christine Ross, client director at Handelsbanken Wealth Management.
Before you try to help a younger relative get on to the property ladder, there are some important factors to consider.
Can I afford it?
If asked to help fund a property purchase, the first question Bomad needs to ask is whether it can afford to advance the cash.
Pension freedoms mean the over-55s can unlock money inside their pensions — a milestone that often coincides with the age adult children leave home. However, experts stress you should not advance a gift or loan if it’s likely you will need that money in retirement.
“You need to talk about social care; you need to talk about major capital purchases like cars and special holidays,” Ross advises. To work out what you could afford, try to calculate your likely annual expenditure in retirement and allow for an ample buffer beyond that before committing to any significant sums.
What are the tax implications of a gift?
Parents and grandparents making substantial gifts often worry about being caught out by inheritance tax (IHT).
Individuals have an annual tax-free gift allowance of £3,000. If you didn’t use this in the last tax year, it can be rolled over to £6,000 per person (so £12,000 for a couple).
Beyond this, any “gifts from existing surplus income” will not be counted for IHT purposes, so long as these do not reduce your standard of living.
However, any larger gifts you make will be subject to the “seven year rule” — if you survive for seven years, they will not count as part of your estate for IHT purposes.
If you die within three years of making the gift, depending on the overall value of your estate, it is possible that your heirs could incur inheritance tax at 40 per cent. This percentage gradually tapers down over the seven-year period.
At the Budget, it was announced that the nil-rate band (an individual’s tax-free threshold before IHT applies) would be frozen at £325,000 until 2026, which means more households will be brought into the IHT net over time.
It is good practice to document any gifts with a letter so that there is a formal record for the executors of your will to refer to for IHT purposes in the future.
To loan or to gift?
The most common motive for lending, rather than gifting, a property deposit is to control where the money goes, Ross says.
In her experience, parents who grant loans rarely need the money back, but use a loan structure “as a method of control, of keeping money in the family”, knowing that a gift might have to be split with an ex-partner following a divorce.
Although a gift would be more tax-efficient, many parents are happy to “forgo the IHT savings for the benefit of knowing that [their child’s] partner is not going to walk off with the money”, she adds.
Most parents opt for an interest-free loan, as they may have to pay income tax on any interest charged.
Be aware that being loaned a deposit could limit the number of mortgage deals your child could apply for and the amount they can borrow, as the repayments will be factored into affordability tests. This means they may end up being able to borrow less than if the money had been a gift.
If you choose to loan, make sure you draw up a loan document with a solicitor to stipulate the terms of the loan and what will happen to that money if it is not fully repaid before your death.
How else can I ensure the money I give is spent according to my wishes?
If you are giving your child a financial gift, there has to be a level of trust to accept that you have no control over what happens to the money once it leaves your account.
That said, there are a couple of things that can be done to help ensure the money is spent as intentioned.
First, Ross recommends asking the recipients to sign a letter of intent stating what they will use the money for. This letter is in no way legally binding but can pull on the conscience of a child or relative and encourage them to spend as agreed.
Second, if the money is given towards a house that will be shared with a partner, a cohabitation agreement or Living Together Agreement (LTA) can be drawn up. This is a legal document common among unmarried couples that establishes how any assets will be divided upon the breakdown of the relationship.
If you are gifting to a child and want to guard against the risk of a future claim being made by an ex-partner, encourage them to draw up an LTA before buying.
Preferential treatment of children — financial or otherwise — is often a bone of contention within families. That said, it is very common to have children in different positions with varying financial needs. Parity is not always about giving each child exactly the same amount of money; it could be giving appropriate amounts according to need.
“The most important thing is transparency,” Ross emphasises. If you are going to start giving money to one child, it is good to be open with all of your children to minimise conflicts over money.