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:
- Financial backing to get older children into the property market.
- Long-term investments in platforms, such as trusts and investment bonds, that mature when the child becomes an adult.
- Targeted support, such as giving seed funding for entrepreneurial children to pursue their business dreams.
Financially backing your children into property
It is wise to be cautious. Parents wanting to help their children into their first home, should be wary of providing security (guarantee) for a child’s mortgage, a common act in today’s stratospheric property markets. In the event of default, the generous parent can become fully responsible for the loan.
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. They can also register security in the property (mortgage) which would normally sit behind the bank who is the primary lender.
Long term investments
Trusts are a common asset-protection vehicle that let parents set aside money for their children, while having discretion as to how income and capital are paid to beneficiaries. The beauty of trust structures is that parents are able to control the funds and how they are distributed to their children without creating an ownership entitlement to the children.
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.
If you are providing targeted support to your children to pursue a business opportunity you should:
- Review and understand their business plan;
- Create an agreement that is signed by all parties which outlines the obligations of all involved; and
- Understand the specific purpose for which the funds will be used.
Rules for financially helping children
- 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.
- Teaching them about the value of saving regularly, along with telling them about the magic of dollar-cost averaging. Dollar-cost averaging involves making regular incremental investments over a period of time rather than making a one-off lump sum investment, thereby reducing the risk of market fluctuations.
- Saving regularly through a diversified investment when children are younger can make a difference to their lives when they become adults. This could ultimately contribute to a deposit on a home or capital to start a business.
Whilst it is easy in the short term to give without consequence remember the saying give a person a fish feed them for a day teach a person how to fish and you feed them for life.