A foot on the ladder
Get it in writing
One option available is to lend the funds and then ensure the agreement is documented in writing. Families can agree upon interest rates, the term of the loan and how it should be repaid. The document should then be signed by the child and the parents. It is not strictly necessary for the loan to be evidenced in writing but doing so reduces the likelihood of disputes and misunderstandings in the years to come.
On the death of the parent, the outstanding loan forms part of the parent’s estate and aggregates with their estate for the purposes of calculating any Inheritance Tax (IHT) liability. It would be up to the executors of the estate – often in consultation with the beneficiaries – to decide whether the outstanding loan should be repaid on the parent’s death. Alternatively, they may honour the existing agreement and allow the loan to be repaid to the estate over the remaining loan repayment term.
If the parents opt not to charge interest on the loan or declare that the loan is to be waived on death, it is likely that the loan would be considered to have been an outright gift. A gift of money to another individual made during a person’s lifetime is a Potentially Exempt Transfer (PET). If a person survives seven years from the date of the gift, the value of the same falls out of their estate for IHT purposes. Conversely, if a person dies within that seven-year period then their child, as recipient of the gift, would be liable to pay IHT on the value of it.
Should interest be charged on the loan, said interest would be deemed as income and taxed at the parents’ own income tax rates. It may be worth considering moving funds between spouses prior to making the gift if interest is to be charged, making use of unused personal income tax allowances.
Treating it as an investment
Another option available to the Bank of Mum & Dad is to treat the transaction as an investment and retain an interest in the equity of the property in much the same way a mortgage lender would. Over the years, they should benefit from realising capital growth and potentially an income if the property is rented out. Careful consideration should be given to the Stamp Duty Land Tax and Capital Gains Tax implications of owning an interest in a second home. Either way, an interest of this nature should be clearly documented in the form of a Declaration of Trust.
Gifting or lending money can be an effective way of tax planning, provided that a person is financially comfortable and can afford to give up the cash. However, it is easy to disregard the wider implications of lending or gifting often significant sums of money to family, so seeking advice as to the options available to protect both parties could prove invaluable.