Bank of Mum and Dad: Can you afford to help as much as you’d like?

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Before the pandemic, and the financial challenges many faced due to furlough schemes and the three national lockdowns, the “Bank of Mum and Dad” was primarily used to help young adults get a foot on the property ladder.

According to research from Legal & General, gifts from parents, grandparents, close friends and relatives accounted for more than half of all house purchase deposits among under-35s in 2020.

Since the coronavirus pandemic began, 25% of parents have provided financial support to their offspring, paying out an average of £1,922 since March 2020. 13% of parents say they have paid more than £5,000 to help their children out.

The Bank of Mum and Dad helps with living costs

New research from Aldermore suggests that financial support from parents isn’t only about helping adult children buy homes. In the last 12 months, parents also assisted their children with living costs:

  • 8% helped to cover household bills
  • 6% contributed to rent payments
  • 5% welcomed children returning home
  • 5% helped to pay off debt.

Since the beginning of the coronavirus crisis, parents have been even more generous. 18% of parents say they want to give at least 50% more to help their offspring.

The same study reports that:

  • 39% of parents are using their cash savings
  • 27% are using inherited funds
  • 12% are downsizing to help their children buy their own home.

But if you are the “Bank of Mum and Dad”, you may face the hard choice between helping your children out and making sure you have enough savings to pay for your retirement years.

Using savings or taking money from your pension pot to help your children could jeopardise your own financial stability. So, how do you weigh up how much you’d like to help with what you can afford? Read on to find out what you need to consider.

Can you really afford to help?

The most important thing to work out is if you can afford to help and, if so, how much can you give without weakening your own financial position.

Pension Freedoms mean you can unlock money inside your pension if you’re 55 or over. But using your pension pot to help your child will reduce the amount of money available to you in retirement.

To work out what you can truly afford to give, you need to calculate your likely annual expenditure when you retire. Remember to leave yourself with a comfortable cushion to cover the unexpected.

Remember to consider the tax implications

Clients often ask us about the tax implications of gifting substantial sums. Parents and grandparents alike worry that they could be caught out by Inheritance Tax (IHT).

Everyone has an annual tax-free gift allowance of £3,000. If you didn’t make use of this allowance in the last tax year, you can roll it over to £6,000 per person. So, if you’re a couple you can gift up to £12,000 incurring no tax charges, if you each have two years’ allowance available.

There are other ways to mitigate Inheritance Tax, so talk to us if you’d like to explore your options.

Use surplus income to avoid Inheritance Tax

If you have enough income and can maintain your standard of living, it’s possible to make gifts from surplus income. If you use this exemption, you must ensure you keep good records of these gifts to avoid a possible IHT charge when you die.

The rules surrounding this surplus income exemption are complex, so it’s wise to seek expert advice to avoid making any mistakes. Typically, the gifts must come from income (not capital), be regular, and not affect your standard of living.

Otherwise, any larger financial gifts you make will fall under the seven-year rule: if you survive for seven years following a gift, the money won’t count as part of your estate for IHT purposes.

If you die within three years of making your gift, your beneficiaries may pay IHT at 40% on your estate. Thereafter, the IHT charge tapers down over the seven-year period.

Financial gifts made between three and seven years before your death will be taxed on a sliding scale, called “taper relief”.

Approach financial gift-giving with a level of trust

Generally, you give up any control over money once it has left your account, so when you gift money to your child you should do so with a level of trust.

If you want to ensure the money is spent as originally intended, there are two things you could consider doing:

  1. Ask your child to sign a letter of intent stating how the money will be used. This isn’t legally binding, but it might influence the conscience of your relative and encourage them to stick to the agreed plan.
  2. If you gift money towards a house they’ll share with a partner, you could draw up a cohabitation agreement or Living Together Agreement (LTA). This is quite common among co-habiting couples and establishes how assets will be divided should the relationship break down.

Both these solutions may give you peace of mind that your money will be spent in the way you hoped and won’t be squandered.

Get in touch

If you want to chat about how you can help your children financially without jeopardising your own financial position, please get in touch. Email or call 01937 223055.