We have had many discussions with our clients about whether or not to financially assist their adult children with purchasing a home. Some feel that if they help their children, by giving them money, they may never build a work ethic or understand the value of building wealth. That may be true.
On the flip side, if they help their children financially, you could assist them in overcoming challenging financial obstacles that could otherwise take years, such as coming up with a down payment on a principal residence.
My approach is to have a face-to-face family discussion.
If a parent or grandparent is considering helping the younger generation purchase a home, I would want to see that the children are also doing everything they can to help themselves. If they are spending excessive amounts on other things (fancy vehicles or lots of holidays) and not focused on the goal of home ownership, then chances are that behaviour would still continue. My advice to my clients is that if your child is not willing to make some sacrifices themselves, probably wait until they are ready to do so. This article assumes your child is also making an effort toward home ownership.
Even though your child may be focused, family dynamics also have to be factored in. Some families communicate very well together and others do not. Families who think as one large unit are often further ahead. This article is intended to help families in which the child is taking proactive steps toward home ownership and there is an open line of communication in the family home.
When both of these criteria are met, we can map out very creative strategies that can have many family benefits. An example of one strategy is for parents with high incomes who may be paying as much as 49.8 per cent in income taxes. Instead of investing that money, the parents could help their child get away from paying rent and build equity in a principal residence. If the principal residence increases in value, there would be zero tax. But we digress.
One common hurdle that we often encounter is couples who disagree on whether or not financial support should be provided to a child. Parents may have different opinions and concerns. Some of the concerns may be running out of money themselves in retirement; treating all children equal (if they help one they should help all); marital break-down if the child is in a relationship (will the money they contribute be lost); appreciation of the financial support or lack of (as noted above, will they build a work ethic and value the effort required to build wealth); conflicting priorities (help children purchase a house or help grandchildren with education); and having children with different needs (i.e. disabilities, marital status, different levels of income, grandchildren, location of where they live).
To avoid making this article too long, I will focus on the most common hurdle for first time home buyers — coming up with funds for the down payment. In earlier articles, we outlined that the average selling price of a single-family home and condo in Victoria at the end of September 2019 were $846,500 and $511,600, respectively. To avoid mortgage insurance, down payments for a single-family home and condo in Victoria are $169,300 and $102,320, respectively.
For purposes of this article, we will summarize the discussions with a few short family cases and how the financial support was structured in each situation. For illustration purposes, we will refer to four couples:
Mr. and Mrs. Smith
Mr. and Mrs. Smith have been happily married for 35 years. Together they have three adult children: Penelope, 27; Peter, 30; and Pauline, 32.
During our meeting, I asked Mr. and Mrs. Smith what was new. Mrs. Smith said they were going to be grandparents soon. She mentioned that son Peter is soon to be a father. Mr. Smith mentioned that Peter was living in a small apartment with his wife and that it will be too small for them once they begin having children.
The Smiths are wanting to help Peter with the down payment on a house. They also know that about half of marriages end in divorce and they want to protect the capital if that happens to Peter. Mrs. Smith was also concerned that if they help out Peter, they should also help out Penelope and Pauline equally when they want to purchase a home one day.
Based on this, we completed a financial plan for Mr. and Mrs. Smith. The plan essentially enabled them to set aside one third of the current down payment amount required to avoid mortgage insurance for each child. Our calculations were $169,300 x one third = $56,433.33.
The family meeting involved meeting with their daughter-in-law’s parents and suggesting a strategy. If both sides of their respective families contribute $56,433.33 then it would be equal in the event of a future division. Peter and his wife would also have to save $56,433.33. Once they were able to save this amount then both the Smiths and the daughter-in-law’s parents each matched their savings by contributing $56,433.33.
I then explained that the bank will want to make sure that the gifts are non-repayable and are from immediate family. The bank will require a verification letter that the money is a genuine gift and does not have to be repaid. This letter has to be signed by both the donor (parents) and borrower (Peter and his wife). Below is an example of the verification letter:
This is to confirm that a financial gift in the amount of $56,433.33 has been made to Peter Smith to assist in the purchase of a home. These funds are being provided as a gift and will never have to be repaid.
I further confirm that I am an immediate relative of Peter Smith and that no part of the financial gift is being provided by any third party having any interest, direct or indirect, in the sale or purchase of the property being mortgaged.
Mr. and Mrs. Smith signatures.
Peter Smith’s signature
Peter’s wife and her parents also signed a similar letter for the bank. This situation worked out as planned as both families were in a position to provide financial support.
Mr. and Mrs. Jones
Mr. and Mrs. Jones have been married almost 35 years. They have only one daughter, Donna, 28, who has just finished university. Mr. and Mrs. Jones realize that one day Donna is going to inherit their entire net worth.
We had already updated the financial plan for Mr. and Mrs. Jones to ensure they could provide the financial support for Donna to purchase a house. They also have no hesitation helping Donna get into a home now that she has finished university and has a good paying job. Donna has been looking around for a home and has finally found one.
Even in situations such as this, where the child has the desire and the parents have the financial means, it is still important to sit down and have a family meeting.
Donna is not yet in a long term relationship so now is the ideal time to set up a family meeting. In talking to Mr. and Mrs. Jones, I recommended that we facilitate the first meeting and then assist them in co-ordinating the other meetings.
In the first meeting, we talked to Donna about how good of an opportunity is being presented to her. We walked through the tax component of the financial support the parents were offering. We outlined that financial gifts to adult children are permitted with no attribution of taxable income under the Income Tax Act. We explained that this financial gift comes with significant responsibility and outlined the additional things she needs to work on. We discussed how Mr. and Mrs. Jones would provide the 20 per cent down payment on a house as a gift.
Mr. and Mrs. Jones also agreed to co-sign on the mortgage of $677,200. We provided Donna with some names of individuals she could discuss mortgage options with and let her know the information that the financial institution will need. Mr. and Mrs. Jones will need to go with Donna to the financial institution to finalize the paperwork. We suggested a 20-year amortization on the mortgage.
We also spoke with Donna about how her parents would like her to take out an individual life insurance policy on her life, with her parents being named the beneficiaries. We provided Donna with a quote for a term 20 life insurance policy with the death benefit being equal to the amount of the mortgage the parents are co-signing for ($677,200). The monthly premiums are $31.71. It would be slightly cheaper if premiums were paid annually at $354.
We provided Donna with the name of a few lawyers that she should meet with. As she is building net worth, we felt it was important for her to have a will and power of attorney. We also suggested she speak with the lawyer on how best to financially protect herself in the event she enters into a long-term relationship in the future.
Mr. and Mrs. Taylor
Mr. and Mrs. Taylor have been married for 29 years. The Taylors have a daughter Jessie, 31, who recently got married to Jack. The Taylors also have a son, Jeremy, 34, who is single. Mr. Taylor was a full-time builder who operated a small construction business. Mrs. Taylor also helped on the administrative side of the business. Both are now semi-retired.
Jessie and Jack are both excited to build a life together and have been saving some money together toward a house purchase. Jack has talked to his parents and they were willing to help them out financially. Jessie spoke with her parents and they also wanted to help, but were not sure if they had the financial means. We had completed a financial plan for Mr. and Mrs. Taylor and the earlier retirement meant they were not really in a position to provide financial support toward a house for either child.
There was a very unique solution to this situation. We had a family meeting where Jack’s parents were involved as well. Jessie and Jack had accumulated enough savings to come up with half of the required down payment. They had found a fixer-upper home, in a fantastic location.
The plan that was mapped out was that Jack’s parents were willing to financially contribute the remainder of the required down payment. Mr. and Mrs. Taylor had agreed to help them with fixing up the home.
Essentially their skills and time would save Jessie and Jack a ton of money over the next couple of years. The house had a self-contained suite that also needed to be renovated. Mr. Taylor agreed to work on this as a first priority to enable Jessie and Jack to rent this out quickly and enable them to have a mortgage helper to service the debt.
Mr. and Mrs. Brown
Mr. and Mrs. Brown would like to help their son and daughter-in-law out. Both the son and the daughter-in-law have finished university and are beginning their respective careers. Together they do not have sufficient funds for a down payment, nor do they have the combined income to qualify for a mortgage.
Mr. and Mrs. Brown sat down with their son and daughter-in-law and mapped out a proposal. Mr. and Mrs. Brown would purchase a house and register title in their own name. The plan would involve their son and daughter-in-law paying rent. The rent would be a reduced rate that would cover Mr. and Mrs. Brown’s servicing costs. The reduced rate was agreed upon, in the short term, to enable them to begin saving for the down payment and building up income levels.
They mapped out a five- year plan that would enable them to save the required down payment. By then, their son and daughter-in-law would have higher incomes and be able to qualify for a mortgage. The transfer price for the home would be the original purchase price. If, after five years, the son and daughter-in-law do not appear to be meeting their side of the bargain then it is agreed upon up front that Mr. and Mrs. Brown would be able to sell the house to an arms-length party at fair market value.
Mr. and Mrs. Simpson
Mr. and Mrs. Simpson have two children that are both doing well financially. Each of their children have two children, leaving the Simpson’s with four grandchildren all aged between 20 and 28.
In the estate-planning discussions with the Simpsons and their two children, we discussed different strategies. The two children did not need the money and agreed that the strategy of skipping them and going to the next generation, the four grandchildren, made more sense.
The strategy involved two stages, the first stage would be during their life time and the second stage would be after their passing. Stage one was to provide a lump sum of $200,000 to each grandchild upon three conditions: The grandchild completed a university degree, obtained a full-time job and used the funds as a down payment on a home.
The Simpsons like this approach as they could see the grandchild enjoy the use of these funds during their lifetime. They agreed to have a meeting with the four grandchildren to discuss this first stage.
The second stage was not to be discussed with the grandchildren. Essentially, the second stage left the residual of the Simpson’s estate to the four grandchildren after the second passing. The second stage distribution would likely enable the grandchildren to pay off the remainder of the mortgage.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138.