We all know that living in Australia is pretty expensive these days, especially if you have a hankering for buying residential real estate in a capital city.
Plus, if you are ‘lucky’ enough to get into the real estate market, it usually means you’ve signed yourself up for an enormous mortgage for the rest of your natural life. Baby Boomers, in particular, have long been derided for ‘hogging’ the real estate markets and preventing the next generation from getting a chance to claim their own little bit of dirt.
Whether it’s out of parental love or just sheer guilt, Baby Boomer (and other generation) parents are often keen to give their children a financial helping hand in life.
This monetary love is often in the form of providing a hefty deposit for a home, helping with regular mortgage payments in hard times once the home has been acquired or helping out with private school fees (especially if one parent takes time off work to focus on child-raising, reducing the dual income family to a single income prospect).
Should they give the money to their child or children by way of a gift or a loan?
Certainly giving money as a gift is easiest and ‘cleanest’, and from the parent’s point of view it’s certainly a more magnanimous gesture that they can make to their child than granting them a loan (which has strings attached and seems a bit uncaring, since their child will no doubt be thinking, “Hey, I’m your own flesh and blood, why can’t you just give it to me mum/dad?”).
Plus, they’re going to get it anyway after you die, aren’t they?
Stop and consider these issues first:
1. According to the Australian Bureau of Statistics, there were 121,197 marriages registered and 46,498 divorces granted in Australia in 2014. If we assume that this proportion is reasonably stable over a number of years, this translates to saying that around 38 per cent of marriages in Australia end in divorce.
That’s a better than one in three chance that, if you give money to your child as a gift and they are married, their marriage may fail and that money forms part of the matrimonial property that the couple will fight over in the divorce proceedings.
2. What if the child runs a business? According to the Australian Bureau of Statistics, more than 60 per cent of small businesses cease operating within the first three years of starting. Chances are, your generous gift to your entrepreneurial child will end up in the hands of his or her creditors within three years.
3. Let’s not forget that once the money is given, it’s gone. If a parent has been just a bit too generous, they may have not left enough for themselves for a comfortable, or even adequate, retirement. Remember what happened to King Lear.
What this means is that the only good way to provide money to your children is by way of loan, especially if the loan is significant, under arm’s length documentation signed by all parties – including children’s spouses – and secured by way of registered mortgage over real estate.
Where the parent is in the position of a secured creditor, then in the event that their child becomes the subject of a divorce or relationship breakdown or succumbs to business failure and bankruptcy, the amount of the loan (plus any agreed interest) has to be repaid to the parent first before the child’s outgoing ex-spouse or their unsecured business creditors get a look in.
The fact that the money is given to the child by way of a loan (and particularly if as a secured loan) means that the child hopefully would be encouraged to treat their parent with respect, including assisting with their care when they are old and frail.
If it later transpires that the parent falls upon hard times but the child is doing okay, the parent can ask for the loan or part of it to be repaid.
Finally, if the parent feels that they really don’t intend to ever ask for the money back, they can simply forgive the loan on their death via their will (or even better, set up a testamentary discretionary trust for the child under their will and give the ownership of the loan to that child’s trust as part of their inheritance in order to continue the protection of the loan amount for the benefit of the child and their own family).
Shakespeare may well have said, “Neither borrower nor lender be”, but he wasn’t a very good estate planner.
Brian Hor provides special counsel and estate planning at Townsends Business & Corporate Lawyers.