Tax Implications of Family Loans Explained

When money changes hands between family members, it’s rarely just about the cash. These loans often carry emotional weight and expectations, which can complicate what might otherwise be a straightforward financial transaction. In the UK, it’s important to understand how family loans can affect your tax position, your estate, and even state benefits. With proper planning and documentation, family loans can be a useful tool rather than a source of dispute.

What is a Family Loan?

A family loan is simply a loan between relatives — such as parents lending to children, or siblings helping each other out. Unlike high street lenders, these loans are usually more flexible, with repayment terms tailored to suit both parties. But without clear documentation, family loans risk creating confusion, conflict, and in some cases unintended tax consequences.

Why Consider a Family Loan?

• Flexibility and trust – repayment terms can be shaped around the borrower’s circumstances.

• Helping loved ones – a way to support children with education, a house deposit, or debt consolidation.

• Potentially lower costs – many family loans are interest-free or carry a lower rate than banks.

Still, both sides should formalise the arrangement. A written agreement clarifies expectations and protects against disputes.

Tax Implications in the UK

Inheritance Tax (IHT) Considerations

Family loans can interact with inheritance tax rules:

• If a parent makes a loan and later writes it off, HMRC may treat this as a gift.

• Gifts above the annual exemption (£3,000 per tax year) may fall under the 7-year rule, where they could be taxed if the giver dies within seven years.

• If the loan remains outstanding at death, it’s normally treated as part of the lender’s estate and subject to IHT.

Tip: Keep written records showing whether the transfer was a loan or a gift, as this distinction matters for tax and probate.

Interest on Family Loans

Most family loans are interest-free, which is fine for personal arrangements. However:

• If interest is charged, the lender must declare it to HMRC as taxable income.

• If no interest is charged, there’s no tax liability — but it must be clear it’s a loan, not disguised income.

Child Benefit & Means-Tested Benefits

Family loans don’t normally affect Child Benefit entitlement directly, but they can interact with means-tested benefits (Universal Credit, Housing Benefit, etc.) if savings thresholds are crossed. For example:

• A lump-sum loan repayment might push the lender’s savings above £6,000/£16,000, reducing or eliminating benefit entitlement.

• If a loan is forgiven, it could be treated as a gift and count towards deprivation of assets rules (where someone gives away money to claim higher benefits).

Credit Union Child Benefit Loans

In the UK, some credit unions offer child benefit loans where repayments come directly from child benefit payments. These can be a lifeline but must be managed carefully, as missed payments can affect ongoing benefits.

Benefits and Drawbacks

Pros:

• Lower or no interest compared with banks.

• Flexible repayment terms.

• A way to support family goals.

Cons:

• Risk of disputes if undocumented.

• Possible inheritance tax issues if the loan is forgiven.

• Could impact benefit entitlements depending on circumstances.

Best Practices for Family Loans in the UK

• Document everything – Write a formal loan agreement with amount, repayment terms, and interest (if any).

• Keep records – Track repayments and any forgiveness of debt.

• Consider IHT rules – Especially if loans are large or may be written off in future.

• Get advice – Speak with a solicitor or tax advisor to make sure the arrangement won’t create problems later.