There are pros and cons for parents who want to give their children financial help. Here’s what to consider.
Some cashed-up parents naturally want to give their children a head start financially, but the big question is how best to help them. Financial assistance typically falls into a few broad categories:
- Long-term investments in platforms, such as trusts and investment bonds, that mature when the child becomes an adult.
- Financial backing to get older children into the property market.
- Targeted support, such as giving seed funding for entrepreneurial children to pursue their business dreams.
However, it is wise to be cautious. Bob Budreika, Financial Adviser at Planning for Prosperity, warns parents to be wary of providing security for a child’s mortgage, a common act in today’s stratospheric property markets.
“That’s a time bomb waiting to blow up,” says Budreika, who points out that if a child defaults on their mortgage payments, the parents can potentially pay a high price through the loss of their own assets.
He believes reverse mortgages – a type of home loan that allows people to borrow money using the equity in their home as security – are a safer option for diverting funds to children because the family home is not at risk.
If parents insist on being a guarantor for their child’s mortgage, it is advisable that they agree to a limited guarantee so they are only responsible for part of the loan.
Another option is to take out a parent-to-child loan. Together, with a lender, parents then formally lend money to their child and have a stake in the property, while receiving principal-and-interest repayments on the amount that they lend.
Consider all options
Trusts are a common asset-protection vehicle that lets parents set aside money for their children, while having discretion as to how income and capital are paid to beneficiaries.
Investment bonds, which have features similar to a managed fund, are also popular and can be a tax-effective means of investing for the long-term. Another option could be to set up a superannuation fund on behalf of the child to take advantage of the tax efficiency and compounding effect of such funds.
Whether it is trusts, bonds, mortgage help or some sort of seed funding, Budreika says parents should not gift money to children without doing their due diligence. If a financial arrangement falls apart it can lead to considerable financial and relationship turmoil between family members.
“Families can end up in dispute if it’s not done right,” Budreika says.
Tips for financially helping children
Budreika offers the following tips for parents and children as part of a risk-management strategy:
- If you enter a financial arrangement with your children, create an agreement that is signed by all parties (handshake deals are fraught with danger).
- Get adult children to arrange insurance, such as income protection, so they safeguard the financial interest of all parties.
- Define a purpose or reason for the investment. “If it’s for no reason, people lose sight and they don’t become dedicated to the objective,” he says.