Parents sometimes provide money to children to help with education, buying a home, or starting a business.  That money can be an outright gift that no one ever expects to be repaid or accounted for.  Other times, the money can be a loan to the child or it can be an advance on the future inheritance.

Dealing with Loans at death

If an outstanding loan is possible or expected at the time of your death, you can address it in your Will in one of three ways:

• Forgive the debt, which means that it disappears without affecting your estate in any way.  Even if you plan to forgive the loan, there may be advantages to formalizing the loan as you will see below.
• Demand repayment of the loan.  You might do this if the amount of the loan is a large part of your estate and the money is needed to provide an inheritance to other beneficiaries
• Require the amount of the debt be deducted from the debtor’s share of your estate and then forgiven.  You might do this if the amount of the loan is relatively small but you want to be fair to other beneficiaries who weren’t lent money.

Advances

If you have given money to a beneficiary with the expectation that the amount is an advance of the beneficiary’s inheritance, then you would require the amount of the advance be deducted from the beneficiary’s share of your estate.    If this is your intention, then make sure you keep careful records of any amounts advanced to your beneficiaries.

Example of formalizing a gift as a loan

Calvin and Penny have one son, Howie, Instead of leaving money as an inheritance, Penny would like to give Howie some of his inheritance now and put the money towards the down payment down on his first home to get him started in life.

Upon some advice from his financial advisor, Calvin and Penny decided they would formalize the gift as a loan even though they intended to forgive the loan.

A couple of years later this proved to be a great strategy because Howie started dating Melanie and very quickly, Melanie moved in with Howie as they started to fall in love fast.  Unfortunately, their relationship did not work out and things got pretty ugly.  Melinda decided she wanted to take Howie for everything he was worth including the house.  The good news is the original down payment was borrowed money (as per the promisary note) and there was no question that Calvin and Penny would get their money back before the house and other assets were split.

Good Estate Planning:  Equalizing the estate

Rod and Lara have three adult children.  Two children are financially independent.  One child, Melody, is 34 years old and lives apart from her parents, but always seems to be short of money.

Melody has been many things in her life:  a university student (to be a marine biologist), waitress, dance instructor (modern dance is her true love), retail clerk, dance studio owner, and homeowner (she was settling down).  Melody has now returned to being a dance instructor.

Melody’s parents paid $16,000 for her uncompleted education, loaned her $40,000 for the dance studio, loaned her $80,000 to buy a house, and have given her money often to help pay her bills.  The house was sold to pay the dance studio’s debts.  Melody has outstanding balances on her credit cards, bank loans, and car loan.  Melody has never repaid any money to her parents.

Now contemplating their estate planning, Rod and Lara would like to divide their estate equally between their children.  However, they recognize that Melody has already been given much more financial support than their other two children.

In their Wills, the couple account for their support for Melody by:

• ignoring the money paid for her education, since they paid for the education of their other children, too
• ignoring the cash gifts, since they did not keep track of them
• deducting the amount of any outstanding loans owing by Melody from her share of the estate and then forgiving the loans, and
• treating any future cash gifts to Melody as advances of her share of the estate.

Of course, Melody’s share of her parents’ estate will be held in trust for her.

Often loans within families are treated informally but as you can see, there are merits to formalizing loans even if it’s family.

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