Gifting or Lending Money to Family: Which Is Right for You?

What is a Lifetime Gift?

In the context of Inheritance Tax (IHT), a lifetime gift is any transfer of money, property or assets by an individual during their lifetime.

Examples of common lifetime gifts can include:

• Parents giving money to a child, to help them purchase a home.
• Grandparents contributing towards a grandchild’s education.
• Family members gifting cash, towards a wedding or other celebration.
• The transfer of jewellery, artwork or other personal property.

Lifetime gifts are most attractive because of their simplicity. They can enable you to provide immediate financial support, avoid the need for formal documentation and play a role in your wider estate planning.

Through the making of a lifetime gift, you can assist a family, friends or others by making an outright transfer of value to that individual, for example, the transfer of a sum of money from your bank account to theirs.

People often choose to make a lifetime gift because they simply want to help another person ‘without strings’ and they want to see the benefit during their lifetime, for example, seeing a child get onto the property ladder.

There are several reasons why an individual may choose to make a gift rather than a loan, such as simplicity in that once the gift has been made, nothing further needs to be done, and there are no enforcement obligations, estate planning opportunities and the ability to provide immediate assistance without having to have a consideration about loans and repayment expectations, which can cause stress and tension.

However, there are also a number of key implications when considering lifetime gifts:

IHT and the 7-year rule

Making an outright gift during your lifetime has long been an effective way to reduce the value of your personal estate for IHT purposes. With careful planning, passing assets on early and reducing the value of your estate can potentially reduce your estate's tax burden and ensure more of your wealth reaches your loved ones sooner. 

For IHT purposes, a lifetime gift of capital to an individual is a Potentially Exempt Transfer (‘PET’). The transfer is potentially exempt because if you survive a period of 7-years from the making of that gift, the value will fall outside of your Estate. If you fail to survive 7-years from making that gift, the value can be brought back into your Estate when assessing the value of your Estate for IHT.

Every individual has a Nil Rate Band of £325,000 that can be given away on death free of IHT. The Nil Rate Band can also be used up by gifts made during your lifetime if you fail to survive 7 years and the value of that gift is brought back into account. If in the 7-years prior to death an individual makes lifetime gifts with a value exceeding the Nil Rate Band of £325,000, IHT would be payable on the value of those gifts at a rate of up to 40%.

There are various other exemptions available that an individual can use when making lifetime gifts to reduce potential IHT on those gifts.

Loss of Control

Gifts are irrevocable, and therefore, once the gift has been made, you are no longer in control of those funds or assets that have been given away. It may be that a sum of money is gifted with an expectation that those funds will be used towards the purchase of a property.

If a simple, outright gift is made, once the funds leave your account, they are no longer in your control, and thus, you lose control. 

Financial Vulnerability

The individual making the gift may later experience financial difficulties and regret having made the earlier gift. Recovery of the assets gifted may not be possible, given the irrevocable nature of gifting and the consequential loss of control.

Before making a gift, you should be confident that you are financially secure and can withstand a reduction in the value of your estate. It is important that you do not deprive yourself of assets and that you have adequate funds to maintain your standard of living, with sufficient funds available to meet any prospective future needs, including any care fees.

If the local authority considers that you have made an outright gift to avoid care fees, the gift may be looked into further.

Potential Family Disputes

Large ‘undocumented’ gifts can create tensions among family members, particularly if another family member feels aggrieved and perceives that they have been treated unequally.

Other Implications

If the recipient individual is contemplating marriage or is already married, you should also consider the potential implications if that marriage ends in divorce and how any assets gifted would then be treated. If there is no pre or post nuptial agreement in place, any assets gifted could form part of any divorce proceedings.

Similarly, if you are gifting money to help with a house purchase, and that individual is buying with another person, what if there is a relationship breakdown? If those funds are unprotected and there is no declaration of trust in place, there is a risk that those funds may not be returned in full to the recipient.

You should also consider whether the recipient is financially stable, whether there is a risk of bankruptcy, and the impact of the gift.

Instead of making a lifetime gift, it is possible to introduce structure and greater protection through making a loan, with the terms of that loan being recorded and documented.

In simple terms, a loan is a financial arrangement in which someone (the lender) provides funds to another (the borrower), who agrees to repay them at a later date.

When thinking about loans, people often think about bank mortgages and commercial lending. However, individuals can enter into private loan agreements with one another.

Private loans commonly occur between family members, friends, business partners, shareholders, companies and private investors and borrowers.

Although many private loans are informal, they are usually documented in a written loan agreement that clearly sets out the terms of the arrangement and provides protection for both parties.

There are many considerations to be taken into account when considering whether a loan arrangement is suitable:

Repayment

When making a loan, the funds or assets subject to the loan will remain repayable in accordance with the terms of the loan agreement.

The loan itself should be documented formally in writing and should set out any repayment terms, including any interest terms. A properly drafted loan agreement should also set out default provisions that explain what happens if any repayments are missed.

Flexibility

Loans are generally more flexible, as the arrangement can be tailored to your needs and circumstances. For example, the loan could be structured to that it is repayable on demand or when certain conditions are met and can be waived in the future, although there are IHT implications associated with waiving a loan, summarised below. 

Security

Some loans are secured against property or other assets, giving the individual making the loan additional protection, especially in the event of nonpayment. 

Loans secured against residential property may be subject to the Financial Services and Markets Act 2000 if certain criteria are met. The circumstances of each arrangement need to be assessed on a case-by-case basis.

Clarity

The parties to the agreement will both sign the agreement to evidence their intentions and obligations and confirm their agreement to the terms. This should reduce the risk of any disputes arising. As the terms are documented, the parties to the agreement should then have a clear understanding of their respective rights and responsibilities.   

Asset Protection

A documented loan agreement may help distinguish the funds from a gift, in situations involving divorce, relationship breakdowns, bankruptcy or disputes between family members.

IHT

Where a loan agreement is entered into, the value associated with the loan still forms part of your Estate for IHT purposes. The loan will be treated as an asset, not a loss of value. Repayment will be dependent on the terms of the loan; however, in general, upon repayment, the value returns to your Estate.

If the loan is later written off, the value may be treated as having been gifted at that point, due to the transfer of value attributable to the writing off of the loan. If estate planning is your objective, making a loan may therefore not be suitable. 

Whilst there are clear benefits of entering into a loan agreement, they do also carry risks. Discussions around loaning and repayment obligations can create tensions, particularly where family members or friends are involved. There are also risks that if the borrower recipient defaults, legal action may be required, resulting in additional costs and stress, and this may further strain relationships.

Before looking to enter into a loan arrangement, it is recommended that the parties seek appropriate legal and tax advice.

Whether a loan arrangement is right will depend on the circumstances, your intentions and your objectives.