The bank of mum and dad

The difficulties of affording a house and the potential for help from the ‘bank of mum and dad’ are often discussed. Parents may be willing to assist and this will commonly be by transferring money to children and because there is no ‘gift tax’ on such payments, it might be thought that this is the end of the matter. However, there may be inheritance tax (IHT) implications.

Generally, a gift of money will be a transfer of value and, subject to any available exemptions, it will be a potentially exempt transfer (PET) for IHT purposes. This means it will not be taken into
account in calculating the donor’s IHT liability if they survive for seven years after the gift. However, if they die within three years, the full amount gifted will be treated as part of their estate. If they die in years four, five, six or seven after the gift, a decreasing proportion is included.

Structure of gifts

The basic principles above mean that the structure of the financial help is important. A one-off lump sum paid towards a deposit or to reduce the mortgage balance will normally be
treated as a PET unless it is covered by one of the standard exemptions. An individual has an annual exemption of £3,000, and any unused amount can be carried forward for one tax year. So, if a parent has not used the previous year’s exemption, they may be able to give up to £6,000 without it being added back into the estate for IHT purposes. If both parents make gifts from their own assets, they may each use their exemptions.

Amounts above those exemptions will become relevant if the donor dies within seven years. In brief (and ignoring the residence nil rate band and other reliefs), the first £325,000 of an estate on death is chargeable at 0%, and any excess is charged at 40%. HMRC looks at gifts in chronological order when deciding whether earlier lifetime gifts have used up the nil-rate band.

Gifts out of income

Regular mortgage payments by a parent may be treated more favourably under the exemption for normal expenditure out of income. This is often the most useful relief where parents intend to help over time rather than by a single large payment. To qualify, the payments must: form part of the parent’s normal expenditure; be made out of income rather than capital; and leave the parent with enough income to maintain their usual standard of living.

HMRC guidance specifically recognises that mortgage payments made on someone else’s behalf may qualify if these conditions are satisfied. In practice, that means the arrangement should
look like a settled pattern, such as a monthly standing order, and should be funded from income such as salary, pension income, rental income or dividends, not from savings or the sale of assets. If the exemption applies, the gift is immediately outside the estate and there is no need to survive seven years.

Documentation is essential. Parents should keep clear records showing the source of the funds, their income and expenditure, and the intention behind the payments. A short letter or note
stating that they intend to make regular payments towards a child’s mortgage from surplus income can be helpful evidence if HMRC later reviews the estate. Bank statements and an annual summary of income and living costs can also support the claim to exemption. Without this, HMRC may treat payments as PETs. Just because payments are made directly to a lender rather than the child, for IHT purposes, a payment made on the child’s behalf can still be a gift.

Conclusion

While the IHT considerations must be considered, there are wider estate planning points to consider. Large gifts could reduce the parents’ own financial resilience, particularly if care costs or changes in income arise later. Also, will gifts to one child raise fairness issues between siblings?

Practical tip

As an alternative, parents could simply loan money to their children. Because this is repayable in future, there should be no IHT and funds may be protected in case of financial difficulty or
divorce.

Disclaimer: The information provided on AccountingFirms.co.uk is for general informational purposes only and should not be considered professional accounting, tax, or legal advice. Always consult a qualified accountant or tax adviser for advice tailored to your individual circumstances.