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Those of us with children may have already faced the difficult situation where your child asks for money. Should you give it to them? If so, how much and under what conditions? Should you ask for the money to be repaid? These are difficult questions. Not only do they potentially impact a financial plan, but they can also influence your child’s character regarding money as they grow up. In this guide, our financial planning team at WMM offers some thoughts on how to be a good “Bank of Mum and Dad” in 2021. We hope you find this content useful.
The case for lending
Younger people, as a whole, arguably do face tougher financial challenges compared to “Gen X” (those born between the 1960s and early 80s). House prices are 65 times higher than in 1970, but wages are only 36 times higher. University tuition is no longer free, and graduates can face debts in the £10,000s which follow them across their careers. It is, therefore, understandable that many parents want to give their children a financial ‘leg up’ when they leave home.
Should you give money or lend it, however? The former bestows a gift – e.g. a lump sum to help cover the cost of a wedding, house deposit or university – with no obligation to repay. Some will find this route ideal, and turn to tax-efficient saving/investment vehicles such as the Junior ISA to assist. However, there is a case for lending the money with certain conditions of repayment. Doing so can help your child think more carefully about how they spend the money – instilling a sense of responsibility. It can also reinforce the reality that most things in life do not come free, but must be earned.
How much to lend
One survey suggests that parents are amongst the UK’s biggest lenders. In 2019, one study suggested that parents gave £6.3bn to their children – enough to put them 10th in a list if they were counted as mortgage lenders (Clydesdale Bank lent £5bn). This averages to £24,100 for parental contributions to children’s first home purchase, and is likely now to be much higher in 2021. The main thing to emphasise here is that parents should not give/lend so much that they threaten their own financial stability in the short term, or their retirement in the longer term.
Beware of taxes
You may be under the impression that you can give your children as much money as you want, without worrying about tax. This is not the case. Inheritance tax (IHT) can be a particular liability. If you die within three years of money being gifted to your child, then it could be subject to 40% IHT. After that, there is a sliding scale. After 7 years, there could be no IHT due (depending on the timing of any subsequent gifts).
A loan to your child will likely still be subject to IHT when you die, since it will still technically be seen as a “gift” that forms part of your estate. Also, be aware that if you charge interest on your loan to your child, then this will be considered an income which is also subject to tax. This may affect your decision about whether to give or loan money to a child. Also, be aware that loaning money can cause arguments if expectations are not clearly communicated about how and when the sum needs to be repaid. You might want to craft a loan agreement, so everything is clearly spelled out in written form. This can help to avoid potentially harmful disputes later.
Interested in finding out how we can optimise your financial plan? Get in touch today to arrange a free, no-commitment consultation with a member of our team here at WMM.
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