The cost of buying homes in the UK has escalated significantly in the past few years. However, house prices themselves seem to have stagnated –Most likely as a result of a concerted effort by the conservatives to curtail the buy-to-let market (by way of increased stamp duty and loss of the deductibility for mortgage interest for income tax), and possibly even because of the dreaded ‘B’ word!
The average UK house price has settled at around £230,000 (ONS House Price Index, released 13 February 2019). Still many young people struggle to afford a property at this price or to obtain a mortgage for enough to allow them to buy. A recent report from the Institute for Fiscal Studies showed that at least 40% of young buyers are unable to buy even the cheapest homes in their locality.
As a result, they are increasingly turning to the bank of Mum and Dad.
Recent statistics show that nearly 30% of all house purchases in 2018 were bought with funds gifted or loaned by parents to their children. (Legal and General Bank of Mum and Dad Report 2018)
This is in some ways an elegant solution, but not all parents (even if they can afford to do so) are happy to unconditionally part with their hard-earned cash. Any money given to a child outright could be wasted, misspent or be used to repay existing debts. The very nature of a gift means that the donor must give up control over how it is used. There is also the risk that, even if the money is used towards a property purchase, a child may end up in a relationship with an unsuitable partner who could claim a share in the property on a separation. The gifted funds will become vulnerable to claims on a divorce or bankruptcy. There are however ways to safeguard family funds.
One such solution is to enter into a Declaration of Trust with your child. This would set out that on any sale, the money given towards the purchase, should be repaid to the parents. This could be set as a percentage of the initial purchase price, thereby allowing the parents to benefit from any increase in the value of the property. This can be far more lucrative than having money sat in a savings account with current interest rates. As the arrangement is between family members, the parents do have the ability to forego their investment at a later date, if they wish. The money would be treated as a gift at this stage (but also a capital disposal, so capital gains tax needs to be carefully looked at).
There are inheritance tax implications when making lifetime gifts, and there are also possible capital gains tax implications for parents with an interest in their child’s property. We would therefore always advise that parents take legal advice before making lifetime gifts.
This type of declaration of trust may not be appropriate if the child will still require a mortgage for the balance of the purchase price. Most lenders do not like anyone, who is not a party to the mortgage, having an interest in the property. If they are aware that purchase funds are being supplied by a parent or family member, then it is common for the lender to ask for confirmation that the money is an outright gift and that there are no strings attached.
Another option is to set up a lifetime trust which is not tied to the property. Parents could transfer the money into the trust which in turn could loan money to the child to use towards their property purchase. As with the declaration of trust above, mortgage lenders will not normally be happy for the trust to have an interest in the property, and so the loan will be unsecured. Loaning funds in this way could however act as protection on a divorce or separation, as the amount loaned will be a debt of the child which needs to be repaid, rather than a sum gifted to them which then forms part of their own assets.
Of course, the parents could loan the funds directly. However, by using a trust, they can remove those assets from their estate (subject to surviving the requisite amount of time).
This option also prevents the risk of a capital gains tax liabilities for the parents or the trust as they will not own a share in the property. There are however inheritance tax (and potentially other tax) considerations when setting up lifetime trusts so taking advice is crucial. Nevertheless, these are a popular option for parents wishing to gift money away but retain control over the future use of those funds.
If all else fails, you should never underestimate the power of an outright gift. In some circumstances this can be the best solution for the family. This is particularly true in cases where the parents’ estates are larger than their inheritance tax allowances and therefore liable to inheritance tax at 40% on their death. As children will usually be the main beneficiaries of their estate, it is often sensible to make lifetime gifts to them, thereby reducing the size of the parents’ estates and potentially minimising the charge to inheritance tax. This is especially the case when those children are already well established in their careers and relationships.
In some cases, it will be better to make small, regular gifts, whereas in other instances it may be more suitable to make a large cash gift. The tax consequences will vary depending on how the gift is made and the amount involved. The tax treatment can also vary depending on whether other gifts had been made within the previous seven or fourteen years.
Lifetime gifts and trusts can be exceptionally useful but require tailored advice to ensure that they suit your particular circumstances.
If you have any questions about lifetime gifting or tax planning, then please get in touch with our wealth management team for more advice.