Thinking about this (a dangerous practice!). If the parents needed a lump sum now, and adult children could afford to repay it over say 10 years, would there be an opportunity to borrow, and repay via a covenant to parents and get tax relief on it?
Using a covenant to make the repayments on a Life Loan
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Gordon Gekko
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Yes, absolutely. Up to 5% of the child’s income, yes? If the parents have low income, it can be a really neat solution.
Yes, that's what I was thinking. These are mainly aimed at the 'asset rich, cash poor'. A couple on only state pension have head room of about 10k per annum they can earn tax free. I've not looked at covenants for a while, but should be a way to do it, although I had forgotten about the 5% cap per child.
Gordon Gekko
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Just to build on Red Onion’s suggestion re a covenant, I’ve actually run the numbers and it can make massive sense. Take the following scenario:
- OAPs with €30k of pension income
- Funding requirement of €50k
- €50k borrowed from Seniors Money/Spry
- Family member(s) paying tax at 40% covenant €5k a year to the OAPs for a period of 10 years
- The OAPs use the €5k to pay-down the loan each year
- The cost to the family of that €5k is €3k
- After 10 years, the loan balance is approximately €17k
- The family clear that with a bullet payment
- The total cost to the family of clearing the €50k loan is €50k, i.e. no cost, which is great
- By setting a higher covenant payment from the start, but depending on the OAPs’ income level, the bullet payment could also end-up being subject to tax relief (e.g. by upping the covenant to circa €6,700 pa)
- The family members inherit the house and get their €50k back that way
- OAPs with €30k of pension income
- Funding requirement of €50k
- €50k borrowed from Seniors Money/Spry
- Family member(s) paying tax at 40% covenant €5k a year to the OAPs for a period of 10 years
- The OAPs use the €5k to pay-down the loan each year
- The cost to the family of that €5k is €3k
- After 10 years, the loan balance is approximately €17k
- The family clear that with a bullet payment
- The total cost to the family of clearing the €50k loan is €50k, i.e. no cost, which is great
- By setting a higher covenant payment from the start, but depending on the OAPs’ income level, the bullet payment could also end-up being subject to tax relief (e.g. by upping the covenant to circa €6,700 pa)
- The family members inherit the house and get their €50k back that way
This is absolutely brilliant. That's why AAM is so good sometimes. BB should go onto Joe to suggest this.
One thing though, everybody was very agitated about the Fair Deal Scheme. Would that be affected by this. I've no idea as I've no clue about Fair Deal.
Duke of Marmalade
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Careful! Let us not fall into a self delusion trap. The coffee machine saleswoman could just as easily point out that if the €3.5k machine is paid for by covenant there will be a €1.4k tax rebate.This is absolutely brilliant. That's why AAM is so good sometimes. BB should go onto Joe to suggest this.
One thing though, everybody was very agitated about the Fair Deal Scheme. Would that be affected by this. I've no idea as I've no clue about Fair Deal.
Covenants are wonderful things and everyone who is in the right circumstance should fill their boots with them. So imagine you already have your boots filled with covenants. Along comes Seniors Money and you think that is a good thing too but you will see it as completely separate from the covenants, which it is, you may as well argue that your personal tax credits were used to pay the interest.
If by taking the covenant out at the same time as the home loan so that the tax relief appears to pay the interest you are deluding yourself if you think you have managed to manufacture an interest free loan.
No, but we might not have explained all the detail. The covenant is completely separate to the loan. The covenant is available even if there is no loan.
What we're talking about here (and it's not clear as we jumped ahead very quickly, and re-reading it we may have mad it sound like there was zero cost) is in circumstances where parents need a lump sum now, and the children are not in a position to provide them the money immediately, the loan provides a mechanism to immediately access the money needed. All we're talking about is utilising the tax relief of a covenant for the children to effectively repay that loan for them.
The loan reduces the effectiveness of the covenant, because as @Duke of Marmalade correctly points out there is interest to pay on the loan.
Equity release loans in retirement should in my view be used as a last resort, but offer an extremely useful tool when money is needed. Covenants are also an extremely useful tool to provide tax relief for high earning children to support parents with low pensions. This is just pointing out how the 2 can be used together. It it more effective than for example the child borrowing the lump sum, and giving it to the parents.
Duke of Marmalade
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Everything GG says is factually correct as he usually is, but I am cautioning against a self delusional interpretation of what is happening.
Look at it this way. If the circumstances are right (child 40% taxpayer, parent not in tax net; being the maximum opportunity) then the child should do a covenant anyway. Even for their own sake, for if the parent doesn't need the cash it will come back to the child as an inheritance. So now we move on to a completely separate question, should the parent take out a life loan, or buy a coffee machine or even an OJ.
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Covenants are a great idea when they work as outlined in above post, child 40%, parent not in tax net, I availed of them for many years. I'm wondering are they that common though, I know I had to explain to someone in the tax office about them when they actually refused the refund one year for a totally incorrect reason.
Colm Rapple was a great man for explaining them and I took his advice on it many many years ago, back then you could do them to a sibling under 18 too and I did that after my mother died for several years for a brother 12 yrs younger than me until he got to 18.
Colm Rapple was a great man for explaining them and I took his advice on it many many years ago, back then you could do them to a sibling under 18 too and I did that after my mother died for several years for a brother 12 yrs younger than me until he got to 18.
Duke of Marmalade
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Used to be great wheeze for the middle classes to pay school fees etc, I don't think there was even a cap. I took my first DoC very seriously, went to the stamp office to get it stamped. But I have since learnt that they are no hassle at all. Download the DoC template. Have it witnessed and then you're ready to go. It is important, I think, to retain evidence of the payments so bank transfers are best.
When I say no hassle, there is hassle to get the full 40% relief. That is because you have to withhold 20% at source and get the recipient to claim back that 20%. Mine had particular hassle as the recipients were in NI, but it did work in the end.
Would there be any other type of tax on that. Like Gift tax ?
Duke of Marmalade
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It is treated as a transfer of income. So the recipient is subject to income tax on it but if they are in a lower band than the payee there is a net gain. I don' t think it is subject to USC/PRSI, certainly the payee does not get relief for USC/PRSI.