5 Keys to Protecting Your Money and Your Relationships When Lending to Loved Ones
Most of us try to help our loved ones whenever we can and however we can. But when that "help" is money, our best intentions can turn bad very quickly. As uncomfortable as it may feel, if you don't integrate giving and lending into your overall financial plan, you're not just potentially enabling poor financial habits -- you could be jeopardizing your retirement.
On today's show, we discuss five keys to lending money to loved ones that will help you preserve both your nest egg and your dearest relationships.
1. Only lend what you can afford to lose.
Let's look at this candidly: if you're loaning money to your kids or other family members, it’s likely that you may not see that money again. You may decide to forgive the loan, or they simply may not ever be able to pay it back.
But even if you do follow through on some of the action items below to arrange for repayment, assume you're making a gift and not a loan. Then, ask yourself: Can I really afford to give away this money? Is this gift going to throw off any parts of my monthly budget? What about my overall financial plan?
If you do settle on a gift, be aware that the IRS allows an individual to give a maximum of $18,000 per year to a single person without having to file any special tax documents. That means married couples could give $18,000 each to a single person. There's no limit on recipients, so you could give the max to multiple people as well. Recipients do not have to pay taxes on your gift.
2. Make sure your spouse or partner is on board.
At Keen Wealth, we ask married couples and partners to be equally involved in the financial planning process. If one spouse "handles the money," that almost inevitably leads to problems down the line, from mismatched expectations for how money is spent and invested to widows and widowers who suddenly have to learn how to run the household's finances in their 80s.
Gifting money can create another stress point, especially for spouses who have different ideas about parenting. One parent might feel like they're just helping a child get through a rough patch; the other might believe the couple's money is prolonging a "failure to launch."
These can be difficult, and even painful, conversations for a couple to have. Sometimes working with a third-party facilitator, like your Keen Wealth advisor, can help steer the conversation towards a positive resolution.
3. Put the terms in writing.
The IRS does not recognize "handshake loans." If you write a check to your child, the IRS treats that as a gift. For loans, work with your advisor and an attorney to put terms in writing that fulfill the requirements. Make sure to include:
- The date of the loan
- The amount loaned
- Interest rate (must be equal to or greater than Applicable Federal Rates)
- Repayment schedule (Monthly installments? One balloon repayment?)
- Due date for full repayment
Note that if you loan more than $10,000, you'll have to self-report earned interest as income at tax time.
Making your loan more formal will put the onus on the recipient to repay you on time -- and hopefully, make better financial choices going forward so that they won't come knocking for more money. A formal contract also gives you some measure of protection: if the recipient fails to repay you, and you can show the IRS the terms and a record of you asking for repayment, you could be able to deduct the loan as a loss.
4. Consider alternatives.
While gifts and loans are probably the most common ways to help loved ones financially, we have worked with folks who think about things like co-signing on a mortgage or auto loan, or making investments in start-up companies. There are serious pros and cons in these scenarios that you should carefully weigh with your advisor and tax professional.
The biggest potential con: you're on the hook! If that business goes under, or if your child struggles to make those mortgage payments, lenders are going to come looking for any and everyone else who signed on the dotted line. It could be that giving money directly -- even if it's never repaid -- costs you less in the long run.
You might also conclude that what your loved one needs isn't really money. Again, this can lead to some difficult conversations about difficult topics: underemployment, poor budgeting, irresponsible spending, and so on. Don't be afraid to reach out to Keen Wealth if you need help having financial conversations with loved ones. We’re also happy to talk to your family members about potential improvements to their own financial plan and introduce them to our educational resources, such as our podcasts, blogs, webinars, and in-person events.
There's one last alternative that's nearly foolproof: just say no. Tell your loved ones that you have a policy of not loaning or gifting money, under any circumstances. If that feels mean, be generous in other ways, like taking the family on vacations, donating to favorite charities, paying for a grandchild's tuition, or, when the time is right, including loved ones in your legacy plan.
5. Communicate expectations up front.
In financial planning, there's almost always a higher probability of success if individual goals and expectations are as clear as possible. Hold loans and gifts to that same high standard. If you, your spouse, and the would-be benefactor can't agree on terms, remember that "No" is always an option. And in many circumstances, it might be the right choice, and the most helpful in the long run for everyone involved.
Supporting loved ones, charities, and your community can be one of the most rewarding ways to use our money. Come talk to a Keen Wealth advisor and let’s check how your giving goals are aligned with the rest of your comprehensive financial plan.
About Bill
Bill Keen is a financial advisor with over 30 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he focuses on providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to Forbes, U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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