Intergenerational Transfers: Helping Adult Children
When a parent is considering giving or lending a child money, the key question is whether it’s empowering or enabling. You need to structure a transfer that is best for both generations.
There is no question that parents have a hard time being objective about helping their kids financially. This is where a financial advisor can come in, one who doesn’t just run numbers, but gets to know your family and offers advice to include both generations.
Parental help: empowering or enabling?
When a parent is considering giving or lending a child money, the key question is whether the transfer is empowering or enabling. This is where an outside eye can lend some objectivity. It’s easy for loving parents to fall into a trap where they keep giving a needy adult child money without seeing any progress on the part of the child to get on his or her feet. Pouring more money into a stagnant situation is not helpful. But parents may feel they have no choice; if they stop paying, the child could go under (get evicted, lose insurance, default on loans, etc.). In these cases you need to work out a plan. Get help, if needed, to devise a plan that you both can agree to. It might involve reducing the payments little by little or setting a deadline, say 90 days, after which no further payments will be made.
If the transfer promises to be empowering—say it’s a loan to get through school, start a business, or buy a home—be positive and encouraging, but also realistic. Run the numbers to make sure you aren’t depriving yourselves or hurting your own future. Although children receiving such aid may say they’ll be in a position to help their parents later on if necessary (once the business is successful or their degree has gotten them a high-paying job), most parents would prefer to retain their financial independence. Determine how much you can afford to give without impairing your own financial security.
Where is the money coming from?
If you happened to have the money in a liquid account, there will be no penalty or tax associated with the withdrawal. But if you are planning a large gift or loan and the money is currently in an IRA, retirement plan, or investment account, consider the financial repercussions of the withdrawal, such as early withdrawal penalties, income taxes on the distribution, or capital gains taxes from the sale of assets. Also consider the opportunity cost of paying taxes sooner than needed on those retirement plan distributions, or the loss of future investment earnings on the securities that were liquidated. Without proper planning, the loan or gift could cost more than you anticipate.
What will be the impact on other family members?
If you propose to help one child financially, consider seriously how to create equality among the siblings, whether it’s by transferring an equal amount, or revising the will to even things out in the end. The worst legacy a person can leave is squabbling children.
Gift, loan, or investment?
You can make the transfer a loan, with an established interest rate and mutually agreed-upon repayment schedule. The repayment schedule can be tailored to your child’s ability to pay, either spreading it out over many years or calling for payments to start on some date in the future. Another way you can structure it would be to participate in future equity buildup—in other words, it could be an investment for you. If the money was used for the purchase of a home, upon the happening of some event such as sale, refinancing, or the passage of a certain number of years, the property would be appraised and you would get your share of the appreciation on that money. There are many, many ways intergenerational transfers can be structured, but there must be clarity from the outset. Which is it, a gift or a loan? If it’s a gift, say so. If it’s a loan, draw up specific repayment terms, perhaps using a tool like LoanBack. But to hand over a check and mumble something like, “pay me back when you can,” creates uncertainty and could lead to resentments and bad feelings down the road.
What about co-signing a loan?
If you prefer not to give or lend money to your kids, you might consider co-signing a loan. In my view, this is the worst way to do it. You are on the hook for the loan—yet have no control over the repayments. But sometimes it’s the only way a transaction can be done. Under the best-case scenario the child makes the payments on time and your involvement is never needed. This also helps the child build credit. Worst case, the child defaults and you pick up the payments. Such payments would then be considered loans or gifts to the child and be managed accordingly.
Put it in a new light
Much of the press about parents helping children is cast in a negative light, implying that the kids are bums, the parents are pushovers, and no good can come from it. But what if such intergenerational transfers were viewed in more positive terms? The kids get a boost at a time when they need it the most. The parents feel good about being able to help. Family bonds are strengthened. And when the funds are used for investment purposes (as my daughters’ homes have turned out to be), it can actually add to the family pot.
Jay Gershman is the Owner and Founder of Retirement Visions LLC, a West Hartford-based financial planning firm that focuses on comprehensive life planning and financial management. For more information, visit www.allset2retire.com. Information and advice are for guidance only and opinions expressed belong solely to the author. Securities offered through Securities Service Network, LLC. Member FINRA/SIPC. Fee-based services are offered through SSN Advisory, Inc., a registered investment advisor.