Why Your Estate Planner Needs to Know If You’ve Lent Money to Family
According to data from the U.S. Census Bureau, millennials have surpass the baby boomers to officially become the largest generation in the United States. Millennials age range from 18-35 years-old and they are poised to be the engine that drives the U.S. economy in the near future. With that said, many millennials are skipping the traditional bank and obtaining family loans from parents or grandparents instead. Unfortunately, we have all heard stories of families torn apart because of disagreements over money. So, what can you do to make sure your intra-family loans help — rather than hurt — your family?
How Intra-Family Loans Impact Your Estate Plan
As far as estate planning is concerned, money you lend to others is legally an asset. If you decide to loan money to family member(s), the presence of these assets in your estate can be problematic for your surviving family members. This is because your executor and successor trustee are under a legal requirement, known as fiduciary care, to collect the outstanding obligation, even if the other party is a family member.
If the amount of money that you have lent out is significant — and “significant” can be relative — it is important to let us know as we help you plan your estate. For example, if you wish to forgive the debt, there are special terms that must be included in your trust or will for this to happen. On the other hand, you may want the debt to be paid out of the inheritance the borrower is otherwise receiving. In that case, the payment of the debt from the inheritance must be addressed in your estate planning documents.
A Brief Loan Primer
A loan is a legal and financial arrangement where money is borrowed and is expected to be paid back with interest. Generally, a loan involves a promissory note, which is a signed document by the borrower containing a written promise to repay a stated sum of money to the lender in accordance with a schedule, at a specified date, or on demand. In some cases collateral, like real estate or other property, is used to secure the loan. Collateral is something pledged as security for repayment of the loan. If the borrower quits making payments, then the collateral can be taken by the lender.
Intra-Family Lending as an Estate Planning Tool
When properly structured and well documented, loans can be a smart estate planning tool for many families. This is because lenders (usually grandparents or parents) can essentially give access to an inheritance without any immediate gift or estate tax problems, generate a better return on their cash than they could with bank deposits, and borrowers (usually children or grandchildren) can take out loans at interest rates lower than commercial rates and with better terms. In fact, the Internal Revenue Service allows borrowers who are related to one another to pay very low rates on intra-family loans. Furthermore, the total interest paid on these types of transactions over the life of the loan stays within the family. If structured and documented properly, intra-family loans may effectively transfer money within the family, for the purchase of a home, the financing of a business, or any other purpose.
Sometimes loans can be used in sophisticated estate tax planning strategies as a way to shift assets into special estate-tax saving trusts. One variant of this technique is sometimes called an installment sale to a grantor trust. Although this sophisticated strategy and others like it are usually only appropriate for those with a net worth of at least a few million dollars, other types of intra-family loans, perhaps for home improvement, an automobile purchase, or a business, can help families across the wealth spectrum.
Key Takeaways
There are a few key points to keep in mind regarding intra-family loans:
- The loan must be well-documented
- Lenders should usually ask for collateral
- The lender should make sure the borrower can repay the loan, and
- The income and estate tax implications should be examined thoroughly.
We’re Here to Help You
While you were kind enough to help a member of your family by lending him or her money, do not let this become a legal dilemma in the event of your incapacity or after your death. Instead, use your estate plan to specifically express what you want to have happen regarding these assets. Before lending money to family, it is important to carefully consider how the loan should be structured, documented, and repaid. If you (or someone you know) have lent money and have questions about how this affects your estate plan, contact Andre O. McDonald, a knowledgeable Howard County estate planning attorney at (443) 741-1088 to discuss your options.
DISCLAIMER: THE INFORMATION POSTED ON THIS BLOG IS INTENDED FOR EDUCATIONAL PURPOSES ONLY AND IS NOT INTENDED TO CONVEY LEGAL OR TAX ADVICE.
