Despite shrinking household budgets and worries about inflation, the bank of mum and dad remains open for business and appears to be expanding.
However, research from Prudential shows that parents and grandparents are perhaps the most lenient lenders in the UK, with:
- 59% writing off a proportion of the loan
- 34% deciding that none should be repaid.
That’s despite the fact that 77% loaned the money with expectations of getting it back, at least at first.
That’s all well and good for the children and grandchildren who are benefitting from that generosity, but what about the financial stability of the adults lending the money?
Financial issues for family lenders
It’s not always a happy story. According to the report:
- 19% have dipped into their pension funds, or foregone pension contributions to help their children
- 19% have had to make personal sacrifices after lending money to younger generations
- 10% have found themselves short of capital to use in emergencies due to lending money to children or grandchildren
If you are thinking about opening your bank account or savings to help your children or grandchildren, it is important to take precautions to protect yourself from getting into financial difficulties because of doing so.
Tips for parents and grandparents considering helping younger generations financially
Of course, these tips won’t cover all bases, as your family life and circumstances will be different to the next person’s. However, these five things should be at the forefront of your mind before you commit to giving, or lending money.
1. Can you afford it?
The most obvious thing you should consider is whether you will be financially stable once you have helped your child or grandchild.
Irrespective of gift or loan, the main thing is to look at how it will affect your own financial future in the short, medium and long term. That’s where cashflow forecasting software, of the type we use with many of our clients, can be so useful, helping you understand the impact on your finances of lending or gifting money.
2. Where will you take the money from?
If you can afford to lend or gift money to younger generations, you need to decide where it will come from.
Taking out of savings or investments will reduce the amount of capital you have immediately available. Furthermore, withdrawing money from ISAs (Individual Savings Accounts) will reduce the capital you hold tax-efficiently, while selling other investments may trigger a Capital Gains Tax (CGT) bill.
Taking money from pensions can also be problematical. Taking more than the 25% tax-free lump sum available from most defined contribution schemes (Personal Pensions, Stakeholder Pensions, Self-Invested Personal Pensions and the like) may trigger an Income Tax liability. Furthermore, removing money from your pension before you retire could significantly reduce the amount you can pay in to pensions each year. This is a problem for those people who continue to work after taking money from their pension.
Deciding where to take the money from is a decision which needs to be made after careful consideration of all the options. And, dare we say it, expert advice.
3. Loan or gift?
Do you want the money to be returned to you at some point?
If not, it may be worth considering the money as a gift rather than a loan. The pros and cons of each depend on your current stage of life. If the money is a gift, it may have some unintended Inheritance Tax (IHT) benefits. Each year, you can give away:
- Up to £3,000 in gifts
- As many small gifts of up to £250 as you like
- Wedding gifts of £2,500 for grandchildren and £5,000 for children
These are immediately exempt from IHT. However, any sums of money outside of these rules could be subject to a sliding scale of IHT, if you die within seven years of giving the gift.
If the money is a loan, and you are dependent on getting it back at some point, you will need to discuss terms.
4. What are the terms?
According to the Prudential study, 14% of parents and grandparents had a fixed monthly repayment in place when they loaned money and just 8% put their agreement into writing.
If you intend to get your money back and want to be sure that your child or grandchild understands that clearly, setting out repayment terms will be a huge benefit. The agreement becomes even more solid if you write down the terms and you both sign it. This not only ensures that you are entitled to reclaim your money but will reinforce the seriousness of the arrangement.
5. Retaining control
Only 7% of parents stipulate, in their agreement, how the money should be spent. If you are giving or lending money for a specific purchase, such as a car or deposit for a first home, it can be wise to have this in writing too. That way, if your child or grandchild has a moment of madness and spends the money frivolously, you are covered from both a moral and legal standpoint.
It is understandable that you might want to protect the money you give to your child or grandchild from their future spouse. To ensure that your gift or loan stays within the family, you could consider writing this into the terms discussed above.
Making the best decision for you
The answer is financial planning.
Only with a financial plan, or cashflow forecast, can you truly know how giving money away, or writing off a loan will affect your own financial future. You could take a chance and end up being okay. However, without a financial forecast or plan, you are in the dark about your long-term viability.
To talk about lending or gifting money, please get in touch with us on 01664 77 88 99.
