But in today’s times, when children, grandchildren or family members ask for a loan, it is difficult to remember or to follow the words of “The Bard of Avon.”
Let’s ask a few questions.
Can I really afford it? If you have to tap retirement funds; a 401K account, or money set aside to pay off credit card debt or meet your mortgage obligations– then the answer is probably NO. By loaning funds, you might be placing yourself in a difficult financial situation. And remember, if you are no longer “financially solvent” you will not be able to help yourself or anyone else.
Is it a loan, or is it a gift? If you determine that you can afford to loan money, make a loan agreement with specific terms. Too often that “loan” later becomes interpreted as a “gift” as time passes. This leads to many misunderstandings and family conflicts.
What are the limits? There are limits to a gift– According to the IRS, you can gift a stated amount each year to an individual. Exceed that amount and there are tax implications. Consult a financial adviser for information. Tax laws change!
What is the interest? When making a loan, set an interest rate. The reason for this is not because you want to be Scrooge…but rather that there are tax implications to any so-called “interest- free loans.”
Applicable Federal Rates (AFR) are published monthly by the IRS for federal income tax purposes. These rates are used to calculate assigned interest charges.
You would be well-advised to review the AFR before determining the interest rate you will charge. The rates change monthly, for example if you make a loan in July, the AFR could be different than if you make the loan in August.
Interest on loans should not be less than the AFR for the loan to be considered a taxable event and not a gift by the IRS. And keep in mind that annual “gift” limit!
A gift has no strings. If you 'gift' someone money, you basically “renounce” all rights to what the money will be used for. You might think you are giving your adult child the money to build your new grandchild’s college fund, only to find that their spouse decided to buy a new car with the money.
In that case, it might be more advantageous to build a college fund for the grandchild, retaining the funds until the grandchild is ready to attend college.
The gift may become part of joint assets in the case of a divorce. If you ‘gift’ your married child money, those funds could become part of the marital ‘pool’ of money. If your child enters into a divorce half of the money could go to the ex-spouse in the divorce decree/settlement. (I say ‘could’ since state laws differ and there are other laws of marital property to consider.)
Is the request for tuition expenses or medical expenses? Consider that you might be able to pay directly for tuition costs or someone’s medical expenses rather than making a “loan” or a “gift”. Remember, if you do this, will you anticipate “reimbursement” of the tuition or medical expenses?
Ask the help of a professional to learn more, since there can be tax implications.
A question of ‘fairness’: Will the loan or gift cause a problem among siblings? To use an example: You give a substantial monetary gift to one adult child and not to your other adult children. Of course, you are free to do whatever you wish with your money, however, consider the potential emotional consequences.
If you have questions about gifting or making ‘family’ loans, gather advice from a professional before your write that check!
* The advice from Polonius to his son (Shakespeare: Hamlet: Act 1, Scene 3)
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