Funding a down payment for a home is a perennial problem and with deposit rates on the floor, some parents see the small-gift exemption as an ideal mechanism to build up a fund to be used by their children at some point in the future to buy their first home.
But while in many ways the scheme may be a no-brainer – at least for those who have the cash – it’s always wise to do your homework before committing to it.
What is it?
With capital acquisitions tax of the order of 33 per cent and the tax-free inheritance threshold from parent to child down substantially from a high of €542,544 to €335,000, the small-gift exemption is one way parents can avoid potential tax bills.
"The nice thing about it is that it's so simple; it's open to everyone," says Mairead Harbron, senior manager with PwC's entrepreneurial and private business practice.
The exemption means that someone can gift €3,000 to another person each year without any tax bill arising. It’s important to note that the person making the gift does not need to have a relationship with the recipient to avail of the tax exemption; however, it is typically used by parents to gift money to children or grandchildren.
While €3,000 may seem a modest enough amount – at least to some – the numbers can really add up to a hefty down payment on a house.
Transferring €6,000 a year, for example, (€3,000 from each parent) means parents could transfer €240,000 tax free, if they make a transfer every year for 40 years.
This would bring up their total tax-free “inheritance” threshold to €575,000 – some 71 per cent greater than if the parents were not to avail of the exemption. And this could be increased even further if grandparents were also to make gifts to grandchildren.
"It's a complete no-brainer over a long period of time," says Marie Bradley, managing director of Bradley Tax Consulting.
Consider a gift of €3,000 a year from each parent over 25 years, which will come to €150,000. As a comparison, if you were to gift a child €150,000 as a lump sum when they were 25, it could either be given tax free but reduce the child’s overall lifetime CAT allowance for their parents to €185,000, or it would be taxable. And tax on €144,000 (allowing for the exempt €6,000 in that year under the small-gift exemption) comes to €47,520.
It’s a significant sum to have to pay in tax and it can be avoided by paying that money over 25 years at €3,000 or €6,000 each year. For families with significant assets, putting the money away each year as opposed to generating significant tax liabilities can make a lot of sense.
Of course, you’re not obliged to gift the full €3,000. That’s just the maximum threshold. The gift can be anything up to €3,000. You could, for example, set aside €500 a year, which over 25 years would build up a fund worth €12,500 – or you can vary the sum from year to year as resources allow.
It’s not for everyone. For it to make sense, parents should expect to leave in excess of the tax-free thresholds to their children. “And lots of families will never leave €335,000 each to their kids,” says Bradley.
Others, particularly those with expensive properties, will, however. A family with three children and a house worth €1 million and other investments, may see it as a practical way of mitigating any future tax liabilities.
“If you want €335,000 [the tax-free threshold] plus €3,000 for every year of their life – again tax free – that’s what you do,” says Bradley.
The practicalities
Certain steps should be taken to ensure that if Revenue were ever to query the transfer of funds you would be compliant. After all, it would be a shame to go to the bother of saving €6,000 each year only to later discover that it wasn’t done in line with recommended practices.
The key to this is ensuring that you have a record of the annual transfers.
Bradley suggests picking one date to execute the transfer each year – a birthday, for example – and to make sure if transferring €6,000, for example, that the money comes from each parent’s account in two separate amounts.
“Proof is the transfer from one account to the other; so mum should have an account and dad’s contribution should come from his own account.”
You’ll also need to ensure that the account the money is going into is in the name of the child. Typically, parents will pick an account where the child – when under the age of 18 – is the beneficiary but the parents are joint signatories.
Eva O’Brien, a solicitor with Reidy Stafford, recommends something such as a credit union account, bank account, or State savings product, such as savings certificates.
“I think they’re good because they’re safe, you can put the child’s name on it and you’ll have a record that it was €3,000 only given to the child every year,” she advises.
One thing to be careful of with credit unions is that, according to O’Brien, some will allow a child between the ages of 16 and 18 access to the account. “Some parents might not want a teenager to access it if it’s a large amount of money.”
This, of course, is a key concern of the strategy; are you comfortable handing over a pile of money to your child when they turn 18? One way of keeping control is by putting the money into a trust account such as a bare trust, which are products offered by banks or life insurance companies.
With this, while the money in the account can be used only for the purposes of the beneficiary, it does need the signature of the trustee or trustees, which can be the parents, to withdraw money from the account. It might also offer an investment vehicle rather than deposit-type savings.
However, once the child turns 18, legally they should be able to request that the proceeds of the trust are transferred to them, so, again, control is only up to a point.
Look after yourself first
Given the challenges involved in getting on to the housing ladder, parents can feel under pressure to be the “bank of mum and dad”. But this isn’t reason enough to be gifting up to €6,000 a year to your children – money which could be paying off your own mortgage or boosting your pension.
“At society level, it’s nearly expected that parents, who are trying to provide for their own pension or old age, are actually going to help their children in buying a house. It’s very difficult to buy a house these days without some kind of help but a time comes when parents have to think of providing for themselves,” says O’Brien.
So, parents need to make sure that their own finances are in tip-top shape before they start gifting funds to a child.
“This is an irrevocable gift: if you need it down the line, then you’re relying on the goodwill of your children to give it back to you. It legally belongs to the children,” says Harbron, adding that parents can help their children in other ways, such as letting them live at home rent free when they’re older in order to save for a deposit.
Bradley agrees. “You have to be able to afford to play this game. The whole reason for getting tax relief is that you’re beneficially transferring ownership to the child,” she says and she cautions against people raiding the accounts if they fall short of money themselves.
Be comfortable relinquishing control
Parents also need to understand that when they put the money aside for their children, they are gifting it to them. Ultimately, it’s up to the child to decide how the money should be spent.
“Once they turn 18 it’s their money to spend unless you put in further restrictions. It’s an issue that people don’t fully appreciate,” warns Harbron.
One way of keeping some level of control is by establishing a trust account, such as that mentioned above, which will require your signature for a withdrawal. Harbron also suggests informal arrangements, such as keeping internet access to the account at a family level, and warning the child that if the money is spent, future contributions might be in jeopardy.
Others will say they simply didn’t tell their child about the account until the time came to hand it over.
Another option is establishing a family partnership but this is typically worthwhile only if a family has substantial assets to offload as it can be expensive to arrange. Under such an approach, the parents are the managing partners of the partnership and encashments will be at their discretion, so it does offer the control that some may desire.
Other than that, however, parents have to acknowledge that there’s nothing they can do if their son or daughter opts to blow the funds on a hare-brained start-up or trip around the world, rather than a down payment on a home or similar investment in their future.
“I don’t think that if you’re giving a gift, or leaving an inheritance in your will, that you can control it remotely. You have to raise your children and hope that they take on board the advice that you’ve given them over the years,” says O’Brien.
But how the money is ultimately spent can lead to tensions within the family.
“It’s a risk, there’s no other way to put it, it is a risk,” says Harbron. “Once you’ve given the gift, unless you put in a formal structure such as a family partnership, you don’t have that control mechanism. So your only hope is using your influence as a parent to dictate where it goes.”
