Why you should make loans to your children not gift them money


I am always on the look out for interesting tips for clients and while this may not necessarily be SMSF related, many of my readers are also wish to help their children with money for house deposits, education funds or other ad-hoc expenses .  I read the blogs from Dr. Brett Davies at Legal Consolidated regularly and found them very informative and excellent guidance so, with his permission, I am “paying it forward” again!

In his blog Parents making loans to children he discusses why smart parents use loan agreements to protect the family wealth. Here is the detailed article and video he prepared.

Parents making loans to children

Sad parents

Mum and dad give their daughter, Joanne $400,000 to buy a house. She then marries Ken. Ten years later Joanne and Ken divorce. The house is still worth $400,000. It is the only asset of the marriage. The Family Court awards $200,000 to Ken. The Family Court is not interested that the money was a gift from Joanne’s mum and dad. Instead, loans to children are safer.

Smart parents

Mum and dad lend $400,000 to their daughter, Joanne. Joanne signs a legally prepared Loan Agreement built on Legal Consolidated’s website. Joanne purchases a house with the money. She marries Ken. Ten years later they divorce. The house is still worth $400,000. It is the only asset. The Family Court is shown the Loan Agreement. The Family Court orders that Ken gets nothing. This is because the assets of the marriage are nil.

To protect your loan build a legally prepared Loan Agreement – on a law firm’s website. Homemade loan agreements may not work. They carry less weight with the Family Court and Bankruptcy Court. Why take the risk?

But I love my children

There is nothing wrong with helping our children financially. It could be for their first car, grandchildren school fees, a holiday or a property. Today it is becoming more popular to help out our children with a home deposit, but simply giving away the money has real risks. It is important to protect the money in case:

  1. they divorce
  2. go bankrupt

  3. suffer from drugs
  4. suffer a mental condition
  5. stop loving you – ‘King Lear’ offers his daughters his Kingdom for the return of their love, but after they promptly abandon him
  6. you run out of money yourself, in your old age

loans to children

 

Documenting loans to children

Never ‘give’ your children money. Always ‘lend’ them money ‘payable on demand’. Get it back if something goes wrong. Treat yourself like you are a bank, and your children are taking out a loan.

Creating a loan agreement not only protects your own interests but also benefits the child as you can decide in the future to forgive the loan while you are alive or in your Will.

With loans to children, never rely on a verbal agreement. Press the Build button and build a Loan Agreement on our website. We are Australia’s only law firm website providing legal documents online. It puts everything in writing with rules about the loan.

Any tax issues?

There are no tax issues. The interest rate for the loan is ‘as advised by the Lender’. Therefore, while the interest rate is zero you have no income tax issues. If the child separates you can increase the interest rate to draw more money out of the failed relationship. There is less money for the Family Court to give to your ex-in-law.

A loan isn’t always for property and the grandchildren’s school fees. You can also fund the children’s Superannuation fund. Speak to your Financial Planner and Accountant.

At different times, it is common to benefit one child over another with money. If you benefit one child over another then it is adjusted automatically at the time of your death. Say you lend one child $500k and the other child $300k then that is adjusted at your death. So it is all fair again.

When making loans to children:

  1. talk with all your children together about the loans
  2. never gift children money – only loan them money (this protects both you and them).
  • don’t rely on home-made loans or IOUs – build a Loan Agreement

  •  

    loan agreement legal consolidated brett davies lawyers

    Can I just do a Loan Agreement on the back of an envelope?

    In the movies, IOUs are often handwritten on a piece of paper. Sometimes instead of a Loan Agreement, someone does a ‘minute’. Both approaches fail. In Rowntree v FCT [2018] FCA 182 shows the additional care required to document even simple related-party transactions, such as loans. In this case, the taxpayer, a practising NSW lawyer, claimed he borrowed over $4m from his group of private companies. The Court said:

    ‘Mr Rowntree has not deliberately chosen to ignore the law. His evidence presented to the Tribunal suggests that he genuinely believed that there were arguments to support his view that a loan was in existence.’

    He failed. Only a legally prepared Loan Agreement satisfies the ATO, Bankruptcy Courts and Family Court.

    Cheeky son refuses to pay Dad back

    In Berghan v Berghan [2017] QCA 236 the son borrows money from his Queensland aged father. The son refuses to pay it back.

    The son, in the first court case, successfully argues that the monies were given to him as a gift.  However, the Court of Appeal held that the amounts were loans.

    Portrait of an ungrateful childchild loan agreement

    The son’s company suffers financial stress.  The son gets $98k from this Dad. The boy continues to borrow more money from dad.

    Later, the son borrows his father’s credit card. The boy clocks up another $13k of debt.

    The First court case

    His Honour said that Dad failed to prove a legal binding agreement. There was no paperwork. There was no written loan agreement.  It was a gift.

    The Judge said:

    • The son promised to look after his Dad in old age. But that was just a moral obligation.
    • Dad is making the payments to the son, for the benefit of the company, was simply discharging his parental obligations. This is because their daughter was an employee at the son’s company.  The money was therefore of a charitable nature. Dad was protecting the son’s company so his daughter would keep her job.
    • Dad allowed his boy to use the credit card when the boy was injured and impecunious.  These circumstances are charitable.

    Good sense prevails in the Appeal

    The Court of Appeal had a better sense:

    • The lengthy period it took Dad to make a demand for the money does not count against his assertion that a breach of contract existed. The Court held post-contractual conduct is not taken into account when interpreting the terms of a contract.
    • The motive Dad had in transferring his son the money, be it “charitable” or otherwise, was not relevant.

    The Court set aside the decision of the District Court.  The Court said that the monies were paid with an understanding that they would be repaid. This was an “inescapable conclusion”. The transactions were a contract of loan. The Court gave judgement in favour of Dad of $286,000 including interest.

    This is another example of elder abuse. The decision shows the perils of not signing a loan agreement. Going to Court – twice in this instance – was expensive and exhausting for the aging father.

    What happens if your child has a partner and buys a home?

    What if your child has a partner? The loan agreement may change depending on whose name the home is purchased under. Best that your child signs the Loan Agreement and buys the home just in their name. This binds your child alone, and the partner has no say in the matter. What if the partner objects? It is important to stay firm and explain it is ‘to protect your interests, it is nothing personal’. This protects yourself and your child, if the relationship with the partner does not end up ‘happily ever after’.

    What happens if the home is purchased in both your child and their partner’s name? Then both your child and their partner sign the Loan Agreement. Our Loan Agreements allows the loan to be lodged as a caveat. Or our Loan Agreement can be registered as a second mortgage – but the bank is notified. So caveats are more common.

    Visit Parents making loans to children  to start the process or seek legal advice form your own Solicitor.

    We are in no way connected to Legal Consolidated, we do not receive referral fees or commissions of any sort from them. This is purely general advice from a trusted source and you should seek legal advice form them or your own solicitor before making any decision.

    Looking for an adviser that will keep you up to date and provide guidance and tips like in this blog? Then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options. Do it! Make 2019 the year to get organised or it will be 2029 before you know it.

    Please consider passing on this article to family or friends. Pay it forward!

    Liam Shorte B.Bus SSA™ AFP

    Financial Planner & SMSF Specialist Advisor™

    SMSF Specialist Adviser 

     Follow SMSFCoach on Twitter Liam Shorte on Linkedin NextGen Wealth on Facebook   

    Verante Financial Planning

    Tel: 02 98941844, Mobile: 0413 936 299

    PO Box 6002 BHBC, Baulkham Hills NSW 2153

    5/15 Terminus St. Castle Hill NSW 2154

    Corporate Authorised Representative of Viridian Select Pty Ltd ABN 41 621 447 345, AFSL 51572

    This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

     

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