Cashn Clinic: What is the best way to lend my daughter and family £25,000?

Q: I am a lady in my late sixties and I would like to loan my daughter and her family £25,000. I no longer work and I live off my pension, which is small.

I do need to use my savings to top up my pension but I would still have sufficient funds for that even after the loan. Am I able to do this? If I am, could you please tell me the best way to go about it?

NM Aberdeen

A: While you can make a loan to your daughter there are a number of factors you might wish to consider first.

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Upfront, I fully recognise that the lending of money within families can be a sensitive matter, often taking place with little formality and in many cases with no documentation. In most situations this will be sufficient as no complications arise; however I would recommend that unless you are prepared to gift the money with little or no concern, you seek to formalise the arrangements. This allows everyone clarity around what is happening and can avoid uncomfortable discussions further down the line.

Before making the loan it is important you should ensure you can actually afford to proceed with such a loan and that you have sufficient funds to cover any unexpected or emergency expenditure.

You should also consider the impact of the loan on your savings. By making a loan, you will be forgoing the opportunity to keep the money on deposit and earn interest during the period of the loan (albeit I accept at the moment this may not amount to a king’s ransom). To compensate for this loss, you could charge interest on the loan although there would be tax consequences associated with this depending on your own tax position. The interest received represents taxable income and would therefore need to be disclosed in your tax return, or you would need to inform HM Revenue & Customs, assuming your total annual income is currently in excess of your personal allowance. Presumably you are receiving income on the £25,000 at present so this should not significantly change your tax affairs.

Everyone should be clear on the terms and conditions of the loan and you might therefore wish to have a written agreement between yourself and your daughter to avoid any misunderstandings. Any such agreement should detail the amount of the loan, whether it will carry interest and also the repayment terms of the loan. The agreement should cover all eventualities eg what will happen if one of the parties to the loan dies. If you wished you could engage a solicitor to draft such a document, though there would obviously be costs associated with this.

If you do decide to proceed, you should make the loan by way of either cheque or bank transfer so that you have a record of the payment being made. Your daughter could then arrange for a standing order to be set up in respect of the agreed loan repayments.

The loan is still an asset for inheritance tax (IHT) purposes and any amount outstanding at the date of your death will continue to be included in the value of your estate.

IHT will be payable at 40 per cent where the value of your estate, including gifts made in the previous seven years, is in excess of the IHT threshold (currently £325,000) at the date of your death. You could subsequently gift the loan balance to your daughter. This would be a potentially exempt transfer for IHT purposes and would only fall within the value of your estate if you died within seven years of the date of the gift.

l Neil Mitchell is a tax partner at Mazars. Scotsman Publications Ltd and HBJ Gateley accept no liability on the basis of this article