It’s a situation most parents will encounter sooner or later.
A family member, usually an adult child, needs a little financial help.
It could be to cobble together the down payment on that first home, or maybe finance the exit from a difficult marriage, or perhaps fix the car after a fender-bender.
We’ve helped guide many of our clients through the “how to’s” of lending money (or not) to a child … without precipitating a family crisis. And as the divorced mom of two grown kids, I’ve had my share of real-life practice playing CEO of the “bank of mom.”
Here’s a few tips to make it work for you and avoid the family money guilt trap:
1). Clarify whether this is a loan or a gift. What parents consider a loan, kids often perceive as a gift. Make sure you’re on the same page. Which brings us to the next tip …
2). If it’s a loan, get it in writing. Spell out all the terms, including what the interest rate is, when payments are due, and what happens if it’s not paid back. Before parents make a loan to the kids, I like to walk them through what will happen if the adult child stops making payments. It happens, and it’s best to be prepared (see tips #3 and #4).
3). Don’t let your generosity start WWIII among the kids. If your goal is to treat all children equally, it may be better to treat your help as a loan, that if not paid back, will be deducted from that child’s eventual share of the estate (again, make sure to spell this out in writing).
4). If it’s a loan, parents can forgive a portion each year, if they want to, as part of their annual gifts to the kids. The maximum amount you can gift (or forgive) in 2019 without filing any tax forms is $15,000 per person.
5). Before extending any help, make sure you can afford to do so. If it means withdrawing large taxable sums from your IRA or mortgaging your house, you’re better off taking a pass.
Adult kids often ask for help without realizing what your financial situation really is (e.g. they all think their parents are rich), and parents often hate to say no. As the financial advisor, it’s frequently our job to be the bad guy and squash plans that put our clients at financial risk, or restructure family financial aid in a way the helps the recipient without harming the giver. A recent Bankrate study found that 51 percent of Americans are sacrificing their retirement savings to financially help their adult children, and that’s definitely a situation we want clients to avoid at all costs.
6). Explore the other options available. Some of our clients volunteer to help, even before considering other options. For example, one client wanted to help her son finance some home improvements. But the son had good credit, and could easily have qualified for a home equity or other home loan. Those are often much better (and less emotionally charged) alternatives. In this case, neither mom nor son had considered the traditional loan option. Once we pointed them in that direction, the son worked it out on his own and mom stayed out of the lending business.
We had another client whose daughter wanted to borrow money from her mom for grad school. Her mom didn’t want to write a blank check, nor did she fancy the idea of co-signing a long-term educational loan. The compromise? She had her daughter borrow the money under her own name, and offered to help out with some of the monthly loan payments once the daughter successfully finished her course of study and got on her professional feet.
7). Understand the difference between helping and enabling. It’s great to help, but ultimately, the best way you can help your kids is by teaching them to be financially responsible adults. Washington Post columnist Michelle Singletary just wrote a thought-provoking column about when to cut off adult kids financially. Part of letting your kids learn how to be adults is letting them fail, says Michelle.
“It’s through those stumbles that they experience the natural consequences of bad decision-making,” she says. By all means, reach out to help when kids earn it. But say no, says Michelle, when “your adult child is fine with you footing the bills for his smartphone, car insurance and student loans while he’s taking vacations and living it up with his friends at happy hour.” Good advice.