Is money advanced to children by parents a gift or a loan?
In many situations, parents assist their adult children financially to get into the property market. So, is that financial support a gift or a loan? This becomes increasingly messy and widely disputed when that offer of support is complicated by changing circumstances, such as divorce or bankruptcy.
What is the best way to provide children with financial support? In this blog, we look at gifting and lending money, and the options available to ensure this money is used as it was intended to be used.
Some of the most common reasons money is loaned by parents to children are to assist with:
- the purchase of a family home (conveyancing);
- the payment of school fees;
- the purchase of (or injection of cash flow into) a business; or
- the payment of legal or medical fees.
In Australia, there is a legal presumption that money advances are a gift, not a loan, when made from a parent to their child, or from a husband to their wife. The presumption stems from the recognition of legal duties to maintain, natural love and affection between the parties. However, family disputes in court occur frequently today, often because parents have given their children money to buy a house, who later divorce. This means the child’s former spouse ends up with half of that money that was loaned as assets are split.
The issue of gifting money and loans between family members is a growing legal problem that parents don’t take seriously enough.
Today, we’re seeing parents get smarter with how they lend or gift money to their children before handing over their hard-earned cash. The introduction of a Parent Loan Agreement can help to protect both parents and their children from future unforeseen financial consequences.
Through this type of written Parent Loan Agreement, parents can recover the money lent if their child:
- goes bankrupt;
- gets divorced;
- becomes mentally unsound; or
- suffers an addiction-related condition.
These types of agreements can be very flexible and can be tailored to just about any situation. For example, they can state exactly how much is loaned, when and how it is repaid, and any interest rate that will be charged. Parents can also make the loan payable ‘on-demand’, or start charging interest at any time. When the parents no longer want to treat it as a loan but a financial gift, they can forgive the debt by simply signing a Debt Forgiveness Agreement.
Does this money need to be repaid?
Before transferring money across to anyone, it is important to discuss with them and document whether you expect a repayment on the funds. It is important to consider that while you might be in a strong financial situation currently and do not need to request repayment, your situation could change in the future, or your child may choose to share that money with their spouse to go towards a house. It is, therefore, good practice to have the option to request repayment in a written agreement should you ever need to exercise that.
Having a written agreement, like a Parent Loan Agreement, gives you the security for the future, especially if the relationship sours or there is a misunderstanding. It also means that in a dispute negotiation or mediation situation, the terms are well documents and formalised, giving it the capacity to be considered a loan, rather than a verbal agreement which lacks commercial terms and could be presumed to be a gift.
Key takeaways for parents:
- Talk with your spouse or partner so that you are on the same page before you talk to your child about an advance.
- Tell your accountant if it is a loan or a gift.
- Make it clear with your child on what basis you are lending money.
- Get any agreement documented.
Before giving money to your child, carefully consider whether it is being given as a gift or a loan. Even if you intend to offer the money as a gift, having a formal loan agreement, including a payable on demand clause, accounts for the uncertainty of the future and is a smart choice to cover all situations of life. It is much cheaper and less traumatic to sort this out at the outset with a legally valid document, rather than waiting to see what the future might bring and ending up in court.
Our team of experienced lawyers can help you to draft up a loan agreement that is suitable to your and your child’s needs. This will help to protect you and your child in the future. Get in touch with our team today for any questions or advice.