The extraordinary growth in the price of housing in Australia leaves new home buyers increasingly reliant on the ‘bank of Mum and Dad’ to get a foothold in the property market. Six figure cash gifts are increasingly being reported. In many ways this all makes perfect sense: ‘Mum and Dad’ (or whoever the older person is in this scenario) have enjoyed the benefit of increasing house prices. But that benefit has come at the expense of their ‘kids’ who now have to pay higher prices. Rather than wait until Mum and Dad eventually leave an inheritance, many families make the perfectly sensible decision to assist the kids now, while Mum and Dad are still around and the adult kids need a house.
But the movement of money from one person to another raises some questions about the safest way for that money to be transferred. By safe, we mean that various risks need to be thought through and managed. One risk is that money moved from Mum and Dad to their adult child might find its way out of the family. Another is that Mum and Dad might need the money themselves one day.
There are two common scenarios that Mum and Dad should be particularly careful about when providing assistance to their children. The first is the prospect of a relationship breakdown for the adult child. The second is the prospect of the adult child having problems with indebtedness, through something like a business failing, a gambling problem, etc.
The basic point here is that if Mum and Dad simply give their child a cash gift, the money immediately becomes the child’s asset. If the child is then involved in a divorce, for example, the money will usually form part of the marital assets and will be divided along with the other assets. Money that initially came from Mum and Dad could end up leaving the marriage in the hands of a now ex-son or daughter in law.
A common way to manage this kind of risk is to ‘attach strings’ to any money given to the kids. These strings allow Mum and Dad to ‘yank’ the money back if certain things happen. One method to achieve this is to cast the money as a loan, to be repaid under particular conditions, such as whenever the house is sold or experiences a change in ownership. If the loan is properly documented, then the loan would count as a debt of the relationship and would need to be repaid before the relationship assets are divided. Basically, this would let Mum and Dad take their money back, allow the separation to occur, and then re-loan the money again to their newly-single child.
As you can perhaps imagine, once we start talking about loan agreements, careful planning is required. The situation is complex and you should seek professional advice. For example, if the money is cast as a loan, then the adult child will need to declare it when applying for a bank loan, which might reduce the amount that can be borrowed externally. This is one example of how the solution to one problem becomes another problem in itself.
A third thing that Mum and Dad need to consider is whether and when they might need the money themselves. Again, relationship breakdown can be an issue here. But so can other expected changes, such as Mum and Dad retiring or money being needed to assist a sibling, etc. Mum and Dad need to be very clear therefore if there are likely to be situations in which they want the money back.
In addition, there can be issues that arise if Mum and Dad do not provide the same assistance to each of their children while they are alive. It is not uncommon that a gift or loan will be made to some but not all of the adult children. This can often have implications for Mum and Dad’s estate planning.
As a starting point, most parents tend to want to leave their estate to their children in equal portions. This starting point is then altered according to specific factors, such as whether financial assistance has already been given to one or more children. Parents often want to use the distribution of their estate to ‘square the ledger’ between the kids. As you can imagine, it is very important that Mum and Dad have a well-written Will in place for this purpose. It is also very important that the Will be changed if significant assistance is given to one or more children, especially if the current Will simply states that the estate is to be divided equally. Gifts given away before Mum and Dad die do not form part of their estate, and so would not be accounted for with such a simple Will.
As we say above, moving money between generations can solve some problems while creating others. If you are planning to use the bank of Mum and Dad, either as the giver or the receiver, we urge you to give us a call so we can sit down for a consultation, and make sure that you achieve what you are aiming to achieve.