Be smart about lending money to family
There is no expiration date on being a parent. Even if your kids are adults, your natural inclination is to help. And with the highest unemployment rate in more than a quarter century, plenty of people are turning to their parents and other family members for financial assistance. No matter how deep your love for your child, ask yourself whether you can truly afford to help.
Here’s what to consider before lending money to family members:
Your retirement trumps all. There are no loans for retirement. If you deplete your savings, how will you manage your expenses when you retire? Use our Personal Retirement Number calculator to see if you are on track, and whether you can indeed afford to use any savings for a child in need. Don’t tap your 401(k) or Individual Retirement Account (IRA). You want that money to continue to have the opportunity to grow tax deferred for as long as possible.
Don’t touch your emergency fund. Another step is to consider if your security takes priority over helping your child through a hard patch. So be careful raiding your emergency savings fund to help. You want to make sure you always maintain your own safety cushion for your own emergencies. It won’t help your child if you too get into financial difficulty.
Decide if lending money will truly help. Even if you have the money to give, step back for a moment and assess why your child is in this situation. If your help is needed because of their poor budgeting and spending habits, will your money solve a problem or just contribute to the same behavior? If it’s the latter, your child may benefit more from your emotional support in getting them to take control of their financial life. Helping them take a clear-eyed view of their spending habits is a good start.
Understand tax rules for gifts. If you intend to make your assistance an outright gift, you’ll want to steer clear of the gift tax. In 2011 the limit for gift giving without incurring any gift tax consequences is $13,000 per person. So you could give your son $13,000 and your spouse could gift another $13,000 this year without triggering any gift tax consequences. (If your son is married you both could gift $13,000 to his spouse, for a total transfer of $52,000 in 2011.) The money will also be income tax-free to your son and his spouse.
Set clear repayment terms. If the money you lend to family is a loan, create a simple written document that spells out the terms: What interest you will charge, and when repayment begins. Make it part of your agreement that your child should consider using our optional online Bill Pay service to set up automatic payments directly to your checking account.
The more you treat this as a business transaction with clear repayment requirements, the better off you all will be. The last thing you want to do is let a financial deal cause family friction. That doesn’t help anyone.
What’s Next? How to approach savings as a couple
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