Many of those starting out on the property ladder do so with financial help from their parents, with the Bank of Mum and Dad supporting an estimated 49% of all first-time buyers.
This is not without risk however, and parents are increasingly looking to put measures in place to prevent their hard-earned money moving out of the family, in the event of their child’s divorce or death. This can mean making difficult trade-offs and reducing the inheritance tax benefits that come with making substantial gifts to your children, lawyers warn.
Elspeth Neilson, a partner specialising in wills and trusts at Osbornes Law, says, “With average house prices pushing property out of reach for the majority of young people, parents with the means to help are gifting large sums to their children to help them buy their first home.
“Many recognise that they are taking a risk, and that if their child gets divorced or, more rarely, dies, some or all of that money could go to that child’s spouse, and will no longer be kept within the family in the way originally intended.
“Typically, to avoid this, the contribution to the purchase is documented by a ‘declaration of trust’ allowing the parents to retain a beneficial interest in the property, equal to the value of their investment. The downside of this approach is that by retaining that beneficial interest, the money remains in the parents’ estate for inheritance tax purposes.”
Inheritance tax of 40% currently applies to assets worth over £325,000, with each individual able to claim an additional tax-free allowance of £175,000 when a residential property is passed on to a direct descendant, although this tapers if the estate is worth more than £2,000,000. If a parent gives money to their child outright, as long as that parent lives for another seven years, the money is exempt from inheritance tax on their death.
Elspeth says, “It’s a difficult trade off. A declaration of trust means the gift would be ring-fenced in the event of divorce, and in the event of the child’s death, would be passed back to the parents. But it also means that, if their estate is valued at over £325,000, inheritance tax will be payable at 40%, due to the beneficial interest in the property.
“Ultimately parents have to make a decision about what is more important – protecting that lump sum or reducing the inheritance tax bill. Any decision on which approach to take should be based on individual circumstances. Is your child in a new relationship or an established couple? Are there grandchildren who will eventually inherit? Age will also come into the equation with a 50-year-old taking a different approach to someone in their 70s.”
Declarations of trust in a property can be reviewed at any time and therefore decisions made at the time the financial contribution is made can always be changed.
Elspeth explains, “Another option is to start out by maintaining a beneficial interest and, as and when the family’s circumstances change, wind up the trust and make an outright gift of the money, removing it from your estate for inheritance tax purposes.
“If your child is getting married or entering into a civil partnership you could also consider suggesting they draw up a pre-nuptial agreement, stating that in the event of divorce the gift would not form part of the marital assets to be shared between the couple.”