Michelle Bromley CFP®, Director – Strategy & Advice

Many individuals want to assist their family members financially, whether it’s helping with a house deposit, covering unexpected expenses, or funding a new business venture. While this generosity is commendable, lending money to family members without proper documentation can lead to unforeseen financial and legal consequences.

Loans vs. Gifts: What’s the Difference?

At law and for Centrelink purposes, there is a clear distinction between a loan and a gift. If the money isn’t properly documented as a loan, it will likely be deemed a gift. This distinction has significant implications affecting your ability to recover the money, how it may be assessed for Centrelink and Aged Care purposes, and implications for distribution of your Estate.

Social Security and Aged Care

Making a gift or a loan can impact your Age Pension or other Centrelink benefits, or the fees you pay when entering Aged Care, under the means tests.

A loan will be counted as your asset for Centrelink means testing. This means the outstanding loan will be assets tested and subject to the deeming rules, where Centrelink assumes the asset generates income regardless of whether interest is being received. The deeming thresholds for Age Pension recipients are $62,600 for singles and $103,800 combined for a couple. Below the threshold, the deemed rate of 0.25% is applied and anything over the threshold is assumed to earn 2.25%.

A gift may be treated slightly differently. The first $10,000 gifted per annum, up to a maximum of $30,000 over 5 years, is exempt from means testing. Any amount exceeding these limits is considered a deprived asset, meaning it will still be counted as an asset under the means test and deemed to earn income for up to 5 years.

Properly documenting financial transfers, and ensuring that loan repayments are made is essential to avoid unintended consequences.

What Is Required for a Loan to Be Recognised?

To ensure a loan is legally valid and recognised as such:

1. Formal Intent: Both parties must treat the arrangement as a loan. This means avoiding vague or casual agreements where there is no proof of what was decided at the time.
2. Written Loan Agreement: A loan agreement should clearly outline the amount, repayment terms, and any applicable interest. This document should be signed by both parties.
3. Principal and Interest Repayments: A loan normally requires repayments of interest and principal. An interest-free loan may indicate that the amount was intended as a gift.
4. Evidence of Repayments: Regular repayments should be made according to the agreed terms, and records should be maintained. A lack of repayments can suggest that the loan has been forgiven, especially if the statutory limitation period has passed.
5. Declaration of Income: Interest earned on money loaned to the family must be declared in the lender’s income tax return as taxable income.

What Is the Statutory Limitation Period?

The statutory limitation period is the legal timeframe within which you can take action to recover a loan.  In most Australian states and territories, the limitation period for debt recovery is 6 years from the date of the last payment or acknowledgment of the debt. 

If there are no repayments or written acknowledgments within this time, you lose the right to take legal action to recover the money.

Secured Loans vs. Unsecured Loans

When lending money to a family, you should also consider whether the loan will be secured or unsecured. This decision affects both your legal rights and the likelihood of recovering the loan if something goes wrong.

Secured Loans:

• A secured loan is tied to an asset, such as a property, which acts as collateral. 
• If the borrower fails to repay, the lender (you) has the legal right to claim the asset to recover the loan amount. 
• Secured loans are more formalised and provide greater protection, especially for large sums of money. 

Unsecured Loans:

• An unsecured loan isn’t tied to any asset. If the borrower doesn’t repay, recovering the funds can be difficult or impossible without legal action. 
• These loans are typically simpler to set up but carry more risk, especially if the borrower faces financial difficulties. 

While a loan agreement may be as simple as a written agreement signed by both parties, seeking legal advice to establish a formal loan agreement and possibly securing a mortgage against any property the funds are used to purchase, provides added protection for your financial interests.

Estate Planning Considerations 

Loans and gifts have significant implications for estate planning: 

Loans as Assets of Your Estate:

• The outstanding loan becomes an asset of your estate when you pass away. 
• The executor of your will is legally obligated to recover this loan unless your will includes a specific instruction to forgive it. Without this instruction, the borrower may be required to repay the loan, which could cause tension among beneficiaries. 
• If you intend to forgive a loan, this must be clearly stated in your will. A vague or undocumented intention to forgive may lead to disputes and complicate estate administration.  

Gifts and Estate Distribution:

• A gift made prior to death is not ordinarily considered in the distribution of your estate unless you will explicitly state otherwise. For example, if you gift $50,000 to one child before your death, the other beneficiaries may not be compensated for this unless your will specifies how the gift should be treated in the estate calculation. 
• Clearly outlining how prior gifts should be considered ensures fairness and avoids potential disputes among beneficiaries.

Protecting Your Financial Security

Before lending money to your adult children, consider: 

1. ‍Getting Legal Advice: A solicitor can draft a legally binding loan agreement, register any security interests, and advise on the implications for your estate.‍
2. Seeking Financial Advice: An adviser can assess how the loan might impact your financial position and Centrelink entitlements. ‍
3. Discussing Estate Plans: Review your will in conjunction with your estate solicitor to ensure it reflects your intentions regarding loans and gifts.

The Bottom Line 

Helping your children is a generous and meaningful act, but it’s crucial to balance your generosity with proper planning. Whether lending money as a secured or unsecured loan, understanding the statutory limitation period, or planning your estate, clear documentation is essential to avoid the risks of informal arrangements.  

By taking these precautions, you can support your family while protecting your financial future and ensuring your estate is managed according to your wishes.

Contact one of our Wealth Advisers at clientservices@primefinancial.com.au or complete the form below for tailored financial solutions, utilising our strategic knowledge and investment acumen to help you and your family with long-term financial aspirations.

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