Are You Better to Lend or Gift Money to Your Family Members?

At Everlake, we sometimes meet people who have got themselves into a bit of a financial muddle. Often this is a result of them not seeking advice or having received poor financial advice in the past.

The trouble usually relates to tax efficiencies foregone relating to an investment or poor retirement planning decisions.

Sometimes more innovative and effective solutions were missed, either through lack of knowledge or lazy advice. These mistakes can be very expensive.

To take a very simple example – I’m not sure we’ve ever had a client come to us where the parent has given a loan to a child. Many don’t realise that inter-family borrowing can be a very effective financial planning vehicle.

You see, we are big believers in families sharing resources together wherever possible. Creative financial planning for your family, when done right, can save everyone money. It also helps to foster good attitudes to managing money and working together. It’s not without its risks, but these risks shouldn’t put us off trying things!

Take the example of children that have credit cards, car loans, mortgages, or other consumer debts they are repaying. Their interest rates are likely to be significantly higher than the meagre deposit rates that the parents are achieving with their savings. If the parents switch their savings between banks and the post office it will make some difference, but if we’re honest the difference is minimal.

The Bank of Mum and Dad

Instead, you could consider lending them some money and replacing the role of the bank with the Bank of Mum and Dad. Often a phrase used with negative undertones, the ‘Bank of Mum & Dad’ makes sense.

Consider a child thinking about a €20,000 car loan from the bank, to be repaid at an interest rate of 7.5% pa over 5 years. This will mean a regular payment of about €400 per month.

Instead, if you lend your child the €20,000 at a reduced interest rate and they repay you €400 per month. The loan will be repaid well in advance of the 5 years. Both parties gain from this, and you are sharing your family resources.

Of course, there is some risk with this strategy. You may worry that you will not be repaid, he/she will get divorced, become ill or die. For a larger loan you could insure against this, or use legal contracts, but for a smaller loan, perhaps the risk is worth taking?

Those who have savings of more than €100,000 (€200k for a joint account) in any one Irish banking institutions are already taking a risk with their money. The Deposit Guarantee scheme doesn’t protect above €100,000 per person.

Too often, people just jump to the alternative of gifting the €20,000 to the child. But beware the tax implications. The small gift exemption allows you and your spouse to gift €6,000 pa (€3,000 each) to your child. This leaves a Capital Acquisitions Tax charge for your child in relation to the remaining €14,000. Now the gift is not so attractive…

Taxation of Loans

The main issue to determine about the loan is whether you wish for the loan to be interest bearing or interest free, and to consider the tax implications of each of these options.

Pursuant to s.40 of the Capital Acquisitions Tax Consolidation Act 2003, an interest free loan would give rise to a small, deemed gift to your children in respect of this free use of money on 31 December each year.

The value of the deemed gift which would arise for your children under this option will be equal to the best deposit rate obtainable for the funds. However, provided that you are not otherwise utilising the small gift exemption in a year, the deemed gift arising should be covered by the annual small gift exemption of €6,000 from both of you combined (if you are both acting as lenders), so that no capital acquisitions tax liability should arise for your children.

As an alternative, you could provide that interest at a fixed rate (such as 1%) is to be charged under the loan. But that such interest is to be rolled up. It is then not repayable until the the time that the loan is repaid or when the loan is written off by you. This latter option would however ultimately give rise to an income tax liability for you in respect of the interest payable.

Sometimes, just a bit of ‘outside the box’ thinking is needed to deliver real value to clients and their families.

To review your financial circumstances and estate planning opportunities, please get in touch or download our guide

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