Over previous weeks, we have looked at tax and estate planning challenges relating to Unpaid Present Entitlements. A related but separate problem is the question of amounts paid within a family to some – but not all – of the children in a family such as a loan.
Is it a gift? Is it a loan? Or is it just a problem?
In Australia, parents are one of the largest sources of finance and a loan for first home buyers. The average parental loan is reportedly $90,000.00, but unfortunately, you can’t move a sum this large around without generating legal risks.
Is the transfer a gift or a loan? If it’s a loan, is it secured? If it’s secured, is the collateral owned in such a way that the parent’s interest is liable to be defeated? And what are the possible estate planning consequences?
Broadly, the Bank of Mum and Dad can provide finance:
- as a gift;
- as an undocumented and/or unsecured loan; or
- as a documented loan with security.
Depending on how the finance is advanced, problems can arise if:
- the recipient child’s relationship ends, with the money or property becoming part of the property settlement;
- the recipient becomes bankrupt; or
- the recipient passes away but the financed property is held as joint tenants. In this case, the surviving spouse becomes the sole owner of the property. Unless he or she is also a signatory/borrower under a documented loan agreement supported by a mortgage, the parents will likely have no claim against the home.
The Estate Planning angle
Consider parents who gift money to one child but not another. Even though they may want to leave their wealth to their two children equally, if their wills nonetheless divide their estate evenly between the children, it will create unintended inequity. This is because the estate is reduced by the gift to the first child, but the balance is still split 50/50 between both kids.
Written agreements and registered mortgages
As a general rule, if parents advance money to their children as a loan (rather than a gift), that loan should be documented and secured.
A formal loan agreement can be useful when having to prove the arrangement to other parties, such as Centrelink. A registered mortgage is also useful, but parents should understand that where a bank has a first mortgage, there will always be a question as to whether the remaining equity in the home will be sufficient to cover the second mortgage.
This is particularly so if the child also has business loans with the bank which may also be secured by the first mortgage.
For information on Unpaid Present Entitlements, click here!