Implications of bank of mum and dad
Claire Johnson, a partner in Clarke Willmott’s private capital team, looks at the implications associated with the so-called ‘Bank of Mum and Dad’ and how parents can make informed choices about contributing to their child’s property purchase.
We talk about the ‘Bank of Mum and Dad’ to describe parents giving their offspring a financial helping hand, particularly in the context of helping them get a foothold on the property ladder. But what is going on under the bonnet in terms of how that help is provided? And what are the implications from a legal and tax perspective?
The implications can be very different depending on how the parents’ financial contribution is provided and what is intended. Is it a gift, a loan, are they investing with their child? A recent survey suggested less than 50% of parents contributing to their child’s property purchase have had the benefit of the advice they need to make informed choices.
There are different ways in which parents can give a financial helping hand, often a very significant sum, sometimes even the whole property value, but there is also a lot that parents need to know about the tax and legal implications when deciding whether to gift, loan or invest with their offspring and how this should be documented.
Studies suggest that in 2023, 61% of first-time buyers who are buying with a mortgage will also be relying on financial help towards their purchase from their parents. An important thing to know, therefore, is that not all mortgage providers have the same approach in these circumstances. The default position, certainly historically, was for mortgage lenders to insist that any financial contribution from a 3rd party, such as a parent, was signed off as being an outright gift. This keeps things simple for the mortgage lender, there is no one else other than the buyer with an interest in the property. But a gift is completely exposed to the child’s choices and circumstances, in the event of a relationship breakdown, for example.
Signing a form indicating that their contribution is a gift may not reflect what the parents intend or wish, particularly if they have paused to consider the potential ramifications of an outright gift. I have come across situations where the mortgage company’s gift form has been duly signed but the parents and child have purported to have some separate understanding between them. This muddying of the waters and the status of the contribution from the parents being unclear is the worst of all worlds, (not to mention a potential breach of the mortgage terms if the mortgage company has effectively been misled)!
Fortunately, the prevalence of ‘the Bank of Mum and Dad’ has led to more high street lenders being prepared to countenance contributions to the property purchase price from 3rd parties being other than by way of outright gift. Parents should carefully examine any form they are being asked to sign to ensure the nature of their contribution is being characterised correctly. In my experience, some of the standard forms can require some manuscript amendments to achieve this.
It is important that parents understand the different tax and legal implications depending on how their contribution is structured and documented so that they can make informed choices.
Making an outright gift
If parents are comfortable making an outright gift and it is something they can afford to do, this does have the merit of keeping things simple. Importantly, for many parents who are concerned to reduce their tax exposure, making a gift is an opportunity to start a 7-year clock running on removing the value of the gift from their estate for inheritance tax purposes. This comes with the added satisfaction of knowing the gift is being made for a worthwhile cause that should benefit their child for years to come, by giving them a foothold on the property ladder. On the other hand, they may or may not have paused to consider that the sum gifted will be completely exposed to the child’s choices and to claims by 3rd parties – for example, in the event of a relationship breakdown if their offspring moves in with a partner or marries.
If parents do want to keep it simple and make a gift, it’s good for them to know that there are steps that their offspring can take to protect what their parents have generously given them. They can make a cohabitation or pre or post nuptial agreement, with any spouse or partner, to agree that family gifts are ring-fenced. In our experience, parents are increasingly encouraging or even insisting upon this ahead of gifting!
Many high street lenders will now allow sums being contributed by parents to the purchase price to be by way of loan rather than gift. This is straightforward to achieve but the temptation to think that nothing formal is needed to document the loan, because it is between close family members, should be resisted!
An appropriate form of loan agreement is a must, clear evidence of the loan is important to help defend against 3rd party claims. The loan can even be secured against the property by way of a second charge (the mortgage lender’s charge will take priority). It is typical to document family loans as interest free and repayable on demand, this keeps the status of the loan simple from a tax perspective.
The downside of the parent’s contribution being by way of loan is that the debt due to the parents remains an asset of their estate for inheritance tax purposes. Parents might consider waiving the loan sometime later, perhaps when their offspring are older and more settled in life. Any such partial or total waiver needs to be done by way of a deed, which is a specific form of legal document, to ensure the waiver is recognised by HMRC as converting the loan to a gift and starting the 7-year clock running on removing the value gifted from the parents’ estate.
Investing in your child’s property purchase
Of course, another avenue parents may wish to explore is investing in the property with their child. They may feel that this still gives them some element of control as well as the possibility of some return on their contribution. There are, however, certain tax ‘downsides’ including a stamp duty surcharge that will apply to the purchase price assuming the parents already own their own property.
There will also be capital gains tax on any rise in value of the parents’ share if, in their lifetime, the property is sold, or they give away their share (assuming they haven’t been living in the property themselves and cannot, therefore, claim principal private residence relief).
Whenever anyone is co-owning a property whether with a parent, friend or a partner, a declaration of trust is an important document, to record who has put in what, and how that equates to their respective percentage shares of the property value.
When putting in place a declaration of trust the share each owner has in the property can be fixed based on what each has put in initially or ‘floating’ to reflect that one party may go on to meet more of the mortgage payments or pay for improvements at some point in the future. The declaration of trust can also cover what has been agreed about who will pay the outgoings and for maintenance of the property and give each of the parties first option to buy the other out if one wants to sell.
Trust planning – a best of both world’s solution?
For parents torn between the inheritance tax planning opportunity afforded by a making gift and a desire to protect the value of their contribution from their child’s circumstances and choices, trust planning offers a neat solution.
This option involves parents setting up and gifting into a discretionary trust for the potential benefit of their adult children and future generations. Although the parents must be excluded from receiving any benefit from the trust assets themselves, they can act as the trustees and, as such, decide when and how best to apply the trust funds for the benefit of their children or grandchildren.
The gift into the trust will start a 7-year clock running to remove the value given from the parents’ estate if they survive the gift by that period. The parents will be able to exercise their discretion as trustees to make a loan of funds from the trust towards their offspring’s property purchase. The loan is owed back to the trust and therefore not wholly exposed in the event of their child’s relationship with a spouse or partner breaking down. The trust can take a charge over the property as security for the loan.
The trustees might decide to waive the loan at some point in the future. Or the loan could remain in place long term for the eventual benefit of successive members of the family bloodline.
This type of trust planning is becoming increasingly popular. Many high street lenders will now accommodate a 3rd party contribution in the form of a loan from a family trust and 2nd charge over the property in favour of the trust.
It is important to be aware that there is a limit on how much can be gifted into trust in any 7-year period (without giving rise to a charge to inheritance tax). This limit is £325,000 if the parent has not previously made any gifts into trust and so that a couple may be able to gift up to £650,000 into trust between them.
Where a combination of a gift into trust and an outright gift is being made, the order of events can become important if there is a failure to survive any of the gifts by 7 years. It is important, therefore, to take specialist advice.
The trust will be subject to its own inheritance tax regime of 10-year anniversary and exit charges at a maximum rate of 6% (with a proportion of the charge being levied if capital leaves the trust between 10-year anniversaries). However, the trust will usually have its own nil rate band in this context. This means that the impact of these charges should be negligible or even nil if the initial gift was within the available nil rate band and all or most of the trust funds are out on interest free loan to beneficiaries. Similarly, if all or most of the funds in the trust are being loaned out to beneficiaries, there may be minimal ongoing trust administration, outside of the trustees keeping the loan arrangements under review (unless and until some change to those arrangements is contemplated).
The key message to take away from all of this is that parents having the benefit of specialist advice is key to them being able to understand the various options and implications, so that they can make an informed choice about what is right for them and ensure the relevant paperwork is in good order.
Claire Johnson has nearly 30 years of legal and tax experience, specialising in helping families and businesses achieve their wealth and succession planning goals.