Jenny Tozer, Partner
The perennial question from many of our clients over the last few years has been "How do we best help our children to get onto the housing ladder?” This has been especially true for London based families who are well aware that affordability is at an all time low, access to low cost funding and fairly priced mortgages are restricted and the recently announced Help to Buy Schemes still require a significant deposit. The new Lifetime ISA will provide a tax effective savings "wrapper" but again, even saving the maximum of £4,000 pa (£5,000 gross) will take years to build up a deposit for a Help to Buy Scheme.
More recently, the additional 3% Stamp Duty Land Tax (SDLT) for second homes, makes a wholly parent-owned purchase of a property less attractive. Rental income will also no longer attract relief at your marginal rate of income tax.
Residential property has traditionally provided an excellent means of diversification of financial assets.
As an asset class, it exhibits a low correlation to equities, fixed interest and cash - diversification can therefore reduce the weighted average risk of a portfolio. Traditionally this asset class shows a low level of volatility, combined with relatively high total returns. Property provides a reasonable hedge against inflation, and it is also a tangible, well understood and utilised asset class. Unlike other asset classes, however, it is less liquid and has a high level of fractional costs (stamp duty, agent fees, legal and mortgage fees etc).
Parents are often keen to help, but don't know how to structure either a gift or loan for a property purchase. Many are now acting not only as guarantor for the loan but are joint mortgage holders. In some cases this is the only way that new entrants to the job market can access mortgages. As joint mortgage applicants, affordability criteria such as net disposable income, cash flow and budget ratios are applied jointly to parents and their children. Banks have recently requested financial statements of up to 5 years, showing levels of expenditure, post tax income and variability of expenditure (i.e. how often an account is in overdraft). Moreover, many of the criteria test affordability ratios with interest rates at 5%, more than double current two year fixed deals. Such strict lending criteria are one of the reasons why portfolio based lending (on loan to value ratios of 60/70%) is becoming increasingly attractive. It is a simple, accessible and cost effective alternative means of funding gifting for residential housing deposits.
If you lend or gift the deposit, there are also issues of structure and control. What happens to your gift if your child marries and later divorces? How do you protect "your" deposit?
The last few Chancellors have levied a series of additional taxes that make holding property in an "envelope" or structure for control purposes, financially unattractive. For a residential purchase within a company, clients can be charged up to 15% stamp duty for Annual Tax on Enveloped Dwellings(ATED). A gift into a trust will attract an immediate 20% charge to Inheritance Tax (IHT) and an additional 6% charge to IHT every 10 years. Partnership structures are considered tax opaque - that is, tax is payable by those in control, and such structures can also trigger unintended income tax and additional stamp duty charges.
Thus control and gifting are not great partners. Control comes at the expense of simplicity and, potentially, tax efficiency.
Any gift must be unconditional and without reservation. The most effective means of reducing IHT is to simply gift and hopefully live for longer than the next seven years. Parents do need to think carefully about their ability to afford such gifts, given their own (and possibly unforeseen) financial requirements.
One thing is for sure, the forecast demand for residential property far outstrips the planned supply across most large cities in the UK. As people are living longer, and tend to do so in their homes, investment in residential property will continue to be an attractive long term asset class - a key reason to help your children if you can afford to do so.