You likely receive calls from older clients who are looking to withdraw some money from their investment accounts to provide some financial assistance to adult children (or grandchildren).
Before you simply cut a check or transfer the funds, there are a few things you and your client should consider to help maintain financial and familial harmony.
Is it a loan…
Rock-bottom rates on savings and fairly strict lending standards mean that clients may be more interested in skipping the bank or credit union and lending directly to family members who can’t easily get it elsewhere.
The parties themselves can determine the interest rate on the loan. But, if it is less than the IRS-required Applicable Federal Rate (AFR), the difference in dollars each year is considered a gift and must be accounted for as such. Go to tinyurl.com/irsafr for the most recent rates. Both the borrower and the lender should consult an attorney to examine any potential legal pitfalls in making the loan. A CPA can address any tax consequences of the interest paid by the borrower and received by the lender. At a minimum, the lender and the borrower should create an agreement outlining the details of the loan, and then sign and retain a copy of the agreement.
... or is it a gift?
If the financial transaction is truly intended as a gift, clients should be aware the IRS allows a person to give up to $14,000 to any other person (including family members) each year with no gift tax or forms required. The donor can exceed that amount if the excess is used to pay education or medical expenses incurred by the beneficiary. Any other uses of the funds exceeding the $14,000 exemption amount requires that the donor submit a Gift Tax Return (Form 709, available at www.irs.gov) when filing their income taxes for the year in which the gifted amount exceeds the $14,000 limit.
Show them the cost
A few thousand dollars given by your clients to their children or grandchildren likely isn’t going to have a significant effect on the clients’ long-term financial security. But, a gift of five or six figures definitely could have a negative impact on the clients’ future, especially if the amount represents a sizable chunk of the clients’ assets. Even if the transaction is set up as a loan that will hopefully be repaid, clients should consider the ramifications if a child can’t (or won’t) pay back the borrowed money. Therefore, you should run some “what if?” scenarios with the client before any large gifts or loans are made.
It’s possible for a client to help out an adult child in need without immediately handing over a large sum of money.
For instance, when a client’s child is struggling to meet monthly bills and obligations, the client might request that the kid add up their monthly expenses, and submit the list to the parent. If the parent approves of the expenses and the amounts, they might offer to send the difference between the child’s income and outgo each month for a certain period of time—say, six months, until the kid can hopefully get back on their feet and become self-supporting.
When a child is requesting a larger loan (for instance, to buy a car), but has been turned down by traditional lenders, the client might offer to co-sign a loan obtained by the child via a bank or credit union, rather than lending or giving the money directly. This approach prevents the client from having to immediately drain their accounts, and may help the child improver their credit score. But, remind the parent that if the kid can’t pay the loan, co-signing the loan means the client may ultimately be responsible for making the payments.
Keep the peace
Any time money changes hands within a family, there is a potential for hurt feelings—especially if one sibling feels that another is getting preferential financial treatment. The situation can often be exacerbated if, as often happens, family members don’t communicate effectively and honestly (especially when it comes to money). When your client is giving money to one child, encourage the client to make the same-sized gift to their other children, when appropriate. If the transfer is a loan, a parent may want to contact the borrower’s siblings to suggest that a similar arrangement is available if the other kids need money in the future. You can help open the lines of communication by offering to host a family conference call or in-person meeting, and facilitate the discussion as well.
Take the blame
There may come a time when a client’s child wants or needs money, but the client either can’t provide the requested funds or doesn’t want to offer assistance. By serving as a “shield,” you can alleviate some of the resentment the child might harbor towards the parent. Tell the client to inform the kid that, “I’d love to help you out, but I checked with my financial advisor and she says I’m not in a position to do that right now.”
You could even offer to talk to the child and (without going into too much detail) confirm that although it’s not possible for the parent to provide assistance, you would be happy to provide the child with any advice or analysis they can use to solve their money problems. Promise to keep the kid’s financial information confidential from the parents, and it will help you earn their trust. A few hours of your time and expertise could help the kid climb out of a financial hole and earn you the parent’s eternal gratitude—along with that of the person who is likely to eventually inherit the parents’ estate.