So, you want to give a child financial help?

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There are pros and cons for parents who want to give their children financial help. Here’s what to consider. 

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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:

  1. Long-term investments in platforms, such as trusts and investment bonds, that mature when the child becomes an adult.
  2. Financial backing to get older children into the property market.
  3. Targeted support, such as giving seed funding for entrepreneurial children to pursue their business dreams.

However, it is wise to be cautious. Bob Budreika, Financial Adviser at Planning for Prosperity, warns parents to be wary of providing security for a child’s mortgage, a common act in today’s stratospheric property markets.

“That’s a time bomb waiting to blow up,” says Budreika, who points out that if a child defaults on their mortgage payments, the parents can potentially pay a high price through the loss of their own assets.

He believes reverse mortgages – a type of home loan that allows people to borrow money using the equity in their home as security – are a safer option for diverting funds to children because the family home is not at risk.

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.

Consider all options

Trusts are a common asset-protection vehicle that lets parents set aside money for their children, while having discretion as to how income and capital are paid to beneficiaries.

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. Another option could be to set up a superannuation fund on behalf of the child to take advantage of the tax efficiency and compounding effect of such funds.

Whether it is trusts, bonds, mortgage help or some sort of seed funding, Budreika says parents should not gift money to children without doing their due diligence. If a financial arrangement falls apart it can lead to considerable financial and relationship turmoil between family members.

“Families can end up in dispute if it’s not done right,” Budreika says.

Tips for financially helping children

Budreika offers the following tips for parents and children as part of a risk-management strategy:

  • 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,” he says.

Budreika maintains that the best gift parents can give their children is 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.

Budreika says 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.

“Creating real wealth is best done over a longer time frame by saving and investing regularly.”

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Important: This article has been prepared without taking account of the objectives, financial or taxation situation or needs of any particular individual. Before acting on the information, you should consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice. Any information used in this article is for illustrative purposes only. Planning for Prosperity is an external entity that is not a member of the Commonwealth Bank of Australia Group of Companies (the Group) and the content or any view expressed by Planning for Prosperity and its employees does not represent an endorsement, recommendation, guarantee or advice in regard to any matter. CBA, nor members of the Group accept any liability for losses or damage arising from any reliance on external parties