Young adults are feeling the pinch. Not only are property prices shockingly high, but student debt and stagnant wages are putting a strain on savings, making it difficult for many young people to even fathom the prospect of affording a house.
Research from the Resolution Foundation shows that millennials are the first generation ever to be worse off financially compared to their parents. So it’s no surprise then that many people in their twenties and thirties are turning to the Bank of Mum and Dad for help getting on the property ladder.
But parents need to think carefully about the difference between simply giving money to their children, lending it to them, or becoming joint purchasers of a property, which all have different tax implications.
Research from Key Retirement found that nearly half of parents and grandparents don’t understand the tax rules on gifting, meaning they are at risk of racking up an unexpected inheritance tax (IHT) bill.
It’s important to be aware that the gift could incur a 40 per cent IHT charge if the giver dies within three years of the money being given, as the money can still count as part of their estate. After that, gifts can be taxed on a sliding scale, starting at 32 per cent after three years, down to eight per cent after six years. And after seven years, gifts don’t count towards the value of the giver’s estate, meaning no IHT is due.
Dean Mirfin, technical director at Key Retirement, says: “when thinking of the best time to make a gift, the seven year rule is obviously the most important because as soon as a gift is made, the clock is ticking.”
One of the obvious rules of thumb, he says, is to avoid gifting all in one go. “It may seem easier to hand over a reasonable sum all at once, when actually the money is not needed and may simply sit in a child’s bank account.”
It’s also a good idea to be aware of the exemptions because each individual is able to give £3,000 in each tax year without being hit with a charge. Wedding gifts up to £5,000 are also exempt from IHT.
Mirfin says an overlooked exemption is gifts out of income, which fall out of your estate immediately provided you can maintain your standard of living after making the gift. This is particularly useful for those with bonus payments.
When gifting away surplus income on a regular basis, Keith Churchouse, chartered financial planner at Chapters Financial, says: “it’s paramount that you document the gift each year to ensure it really was a surplus.”
Sometimes parents can give what they think is an affordable amount, only to find their own circumstances change due to redundancy or ill health, leaving them short of money.
If you don’t have a suitable financial safety net, another option is to lend money in the hope of repayment. “Lending is a good way for parents to keep some control of their cash, which is not an uncommon desire,” says Churchouse.
But be aware that the loan could still be subject to inheritance tax because it will count as part of your estate when you die.
A loan will only be exempt from IHT if you decide to waive the debt and gift the money instead, provided of course you live for at least seven years after granting the gift.
So while it could start off as a loan, the rest of the money could become a gift once you’re sure you won’t need the funds yourself. Just make sure you confirm in writing if you decide that the money has become a gift.
When lending, Helen Morrissey, personal finance specialist at Royal London, warns that it’s important to be clear what the expectations are on both sides and to think through what would happen if repayments could not be kept up.
And even though you might be family members, it would be wise to get the agreement in writing to make the terms clear and avoid issues when winding up the estate.
The personal finance specialist says: “arguments over whether money needs to be repaid, or over what time period, have the potential to cause considerable harm to the parent/child relationship.
“It may seem very formal but all parties should consider taking legal or financial advice and if needs be get something down in writing. Taking this approach can bring much needed clarity to the process and save both parties a lot of grief.”
While most parents choose not to charge their children interest on a loan, if you do then it’s important to bear in mind that you could be taxed on the interest because it will be treated at income.
Also make sure you don’t forget about the loan because your family member could still be liable to pay a nasty IHT charge on your death.
If you’re helping your son or daughter buy a house, an alternative to both gifting or lending is to become a shared owner of the property. But Morrissey warns that this will be regarded as a “second home”, which means you will be charged a higher rate of stamp duty on the transaction.
You will also be liable for capital gains tax on your share of any appreciation in the value of the property. However, parents also need to consider their position if the property needs to be sold after a housing market crash. Morrissey says: “if the property is in negative equity then parents may not see their money returned when they expected.”
While these three options are commonly used to help family members, there are alternatives on the table, such as securing a mortgage against the parents’ home. Just make sure you understand the tax implications before opening your own bank branch.