The hidden risk in gifting: what happens when children divorce?

With the upcoming changes in inheritance tax, parents are increasingly seeking ways to gift money to their children during their lifetimes to avoid or reduce inheritance tax.

If parents are planning to gift or loan money to their children, it is not only important to obtain advice on the most efficient way to do this, but consideration must also be given to their children’s relationship status. If children are married, or planning to marry, the implications of any future divorce must be considered. Gifting money could affect a later divorce settlement, and the child’s spouse may benefit from the parents’ gifts. It is therefore important to understand the family court’s approach to divorcing couples in such situations and how monies may be protected.

Divorce and the family court’s approach

Whether the court considers a payment from parents to be a gift or a loan can have a significant impact on a divorce settlement. A gift can form part of the pot for distribution to the divorcing couple, whereas a loan would be included as a debt on the balance sheet and deemed repayable.

When determining this type of payment in divorce proceedings, reference is often made to it being either a “soft loan” or a “hard loan”. A payment in the absence of any other evidence is likely to be considered a soft loan and regarded as a gift. This means that there could be an unintended outcome in that the payment from the parents ends up benefitting their estranged daughter or son-in-law.

A court will only consider a payment to be a hard loan, and thus repayable, if it has the feel of a normal commercial arrangement. It is a high bar to get over to convince the court that the payment was intended to be a loan.

If the payment was a gift, how that gift was used could have a bearing on the outcome. If a gift of money was received into the child’s joint bank account with their spouse, and the couple used it for their joint benefit, it is likely that what would otherwise be a non-matrimonial asset is in fact “matrimonialised”, and therefore available for sharing on divorce. If a gift was kept entirely separate, it would be considered non-matrimonial. However, if there weren’t enough matrimonial assets to meet the needs of the parties, the court might “invade” non-matrimonial assets to meet needs, or divide the matrimonial assets unequally, expecting the spouse with the gifted money to use that to meet their needs.

How to protect payments in the context of divorce

Depending on the individual situation, the following options could be considered to help protect any gift from being shared during a divorce:

• If the payment is a loan, a formal loan agreement could be prepared to include interest payable, specific events that will trigger repayment of the loan and an outline of repayments. However, a payment in the form of a loan would not reduce the parents’ estates for inheritance tax, as the money would still be due back to them.
• A pre- or post-nuptial agreement, prepared to protect a gift.
• A declaration of trust drawn up if property is purchased using the parents’ money, and the parents’ interest or share can be legally documented. Any share retained by the parents would still be in their estates for inheritance tax.
• A trust arrangement.

The above list is not exhaustive, and it is therefore important to obtain specialist legal advice on your individual circumstances. Failure to properly plan can be expensive and time consuming later.