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Could the bank of mum and dad results in unexpected tax bills?

24th October 2017

Aimed at older parents or grandparents

Young adults in the UK today are under tremendous financial strain. Not only are they dealing with shockingly high property prices, but between student debt, low interest rates and stagnant wages their savings are suffering too. Affording a house of their own is quite simply out of the reach of many young people.

For the first time ever, the millennial generation are worse off financially compared to their parents. So really, it’s not surprising that when the time comes many turn to the Bank of Mum and Dad for a helping hand up and a foothold on the property ladder.

Parents in this situation need to be fully aware of the tax implications involved and the different ways they can pass money to their children without losing out. Unfortunately, many aren’t even aware of what could be lost should they not choose wisely between gifting, lending or shared ownership.

Gifting

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 percent 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.

When deciding on the best time to make a monetary gift, the seven year rule is the most important factor to consider because as soon as the gift is finalised, the Inheritance Tax clock is ticking.

One simple method of reducing risk is to avoid gifting everything at once. While sending it all through as one transaction when the money is not needed may seem easier, but also risks it all being subject to inheritance tax if the giver dies.

Exemptions are a better way around this problem however, 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.

An often-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, it’s paramount that you document the gift each year to ensure it really was a surplus.

Lending

Another common situation involves parents giving what they think is an affordable amount, only for their own circumstances to change due to losing their job or poor health, leaving them short of money.

If you don’t have enough money put away to ensure your financial security should something go awry, another option is to lend money to be repaid later if necessary. This is a good way for parents to keep some control of their funding, which is a fairly common need.

You should however be aware that the loan could still be subject to inheritance tax because it will count as part of your estate when you die. Such a loan will only be exempt if you decide to waive the debt and gift the money instead, provided that you live for at least seven years after granting the gift.

With this in mind, the money you pass to your children could start off as a loan, and become a gift once you’re sure you won’t need it yourself. Just make sure you confirm in writing if you decide that the money has become a gift.

When lending, it’s always 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. Even though you share a personal relationship, it would be wise to get the agreement in writing to make the terms clear and avoid issues when sorting out the estate.

Arguments over whether money needs to be repaid, or over what time period, have the potential to cause real damage to the relationship a parent has with their child.

Although it may seem very formal, all parties should consider taking legal or financial advice and if needs be get something down in writing. Ensuring you take this precaution can bring much needed clarity to the process and avoid any unnecessary disagreements down the line.

Most parents choose not to charge their children interest on the loan, but it’s important to know that if you do, then you can be taxed on it as it will be treated as income. It’s also crucial that you don’t forget about the loan because your family member could still be liable to pay a nasty IHT charge on your death.

Other options

If the loan is to help your child make that first step onto the property ladder, a solid alternative to both gifting or lending is to become a shared owner of the property. But bear in mind 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. On top of this, parents also need to consider their position if the property needs to be sold after a housing market crash. If the property is in negative equity then you may not see your money returned when you expect.

These three options are the most common solutions, but they aren’t the only ones. If you’re planning on doing something like this for your children or grandchildren, it would be wise to have a brief conversation with a financial expert beforehand. A quick call with one of our advisors or arrange a callback and we could help save your children not only a great deal of tax, but also protect your relationship with them by ensuring everything is arranged clearly in advance.

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