Personal legacy planningFamily loans: Should you lend money to your children?

Families with significant assets understand that there’s a fine line between helping their adult children accomplish their goals and ensuring that they achieve financial independence.

If they want to buy a home, start a new business or attend graduate school, for example, is a family loan the smartest route? If so, how should the arrangement be structured? Perhaps more importantly, how might a familial connection affect a financial transaction—and vice versa?

“The first step is to assess how the loan will impact your relationship with your child and their relationships with any siblings,” advises Tom Thiegs, leadership and legacy consultant for Ascent Private Capital Management of U.S. Bank. Introducing lender/debtor dynamics to family requires serious thought to avoid resentment or other complicated interpersonal issues.

The next step is evaluating whether a family loan is the best option for both you and your adult child. Using homeownership as an example, Peter Hatinen, senior vice president and managing director of wealth strategy at Ascent, says a family loan may make sense if the child isn’t creditworthy, lacks the required down payment or needs to move quickly on the purchase. The latter was especially true during the most recent homeownership boom, when buyers were working to outbid one another on the hottest properties.

“If parents can structure an intra-family loan to help the child purchase sooner than they’d otherwise be able to, they can still instill in them a sense of having ‘skin in the game,’ not having guilt over having this nice home that maybe their peers don't have,” says Hatinen, “plus a sense of ownership at the end of the loan cycle.”

Family loan agreement: It all starts with a plan

Whether you’re lending money for a home, to help a child start a business or to assist with a major medical bill, it’s always best to start with a plan. Be sure to include your spouse, partner or other decision-makers in the planning and decision-making process.

“Family members shouldn't just lend money carte blanche and not necessarily know what it's being used for or whether they’re ever going to be repaid,” says Thiegs. “You can ensure the best possible outcome for everyone by laying out a plan that’s both well thought out and followed.”

If a family loan is the best option, lay out a repayment schedule and talk to your child about their capacity to keep up with repayments.

“You don't want to put the recipient in an impossible position or have the situation create family strife,” Hatinen cautions. You should also factor your own financial liquidity into the decision, knowing that any real estate or other illiquid assets may not be easy to access (or may incur fees and/or taxes).

In cases where evaluation produces a “no” decision, Hatinen says it’s important that the child understands why that decision was made.

“Help them understand the context and reasoning behind your decision, and then help them explore other options,” he says. For instance, a child with a good credit score and enough cash for a down payment may still approach their parents first for help buying a house.

“If they haven’t explored other options, walk them through the process of obtaining a loan or mortgage from a bank, plus some of the other ways they can access the funds they need for this specific purchase,” Thiegs suggests.

Family loan taxes and other factors

As always, tax is a factor. For instance, if your child has a solid business plan in place and has asked for a family loan for startup capital, you’ll want to follow IRS gift tax guidelines. For 2023, every taxpayer is entitled to a $17,000 gift tax exclusion for each recipient.t

“If your children are at a stage in life where they’re buying homes, starting families and establishing their careers, then a dollar in their hands may be far more valuable to them than it would be to you.”

-Peter Hatinen, Ascent Private Capital Management of U.S. Bank

If the money is going for college or to cover a large medical expense, you’re entitled to unlimited exclusions for payments made directly to the educational institution or healthcare provider.

“There's also a $12.92 million lifetime exemption from the gift tax, with a 40% tax on top of anything in excess of that amount,” says Hatinen. “Recently, we advocated for taking the ‘low-hanging fruit’ annual exclusion opportunity first for one of our clients; it allows you to give money to your child without the need for a formally structured loan.”

However, using a formal loan structure can also help parents ward off any issues regarding equal financial treatment of—or among—siblings. Where a random gift of $70,000 to cover the cost of a home down payment for one child may invoke envy or even create a problem among siblings, structuring a loan that will be paid back over time can help keep those issues at bay.

Family loans: The question of value

Finally, Hatinen advises parents to weigh the marginal utility of a dollar when deciding whether to lend money to their children. Put simply, consider if the money would be more valuable and tax-advantageous in their hands or yours.

“If your children are at a stage in life where they’re buying homes, starting families and establishing their careers, then a dollar in their hands may be far more valuable to them than it would be to you,” Hatinen explains. “Then, in turn, you may benefit from the tax advantages of lending or gifting it to them.”

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