How a Family Loan Impacts Your Estate Plan

Parents always want to do whatever they can to help their children as they leave the nest and venture out on their own.  Parents often want to help their children start a business or buy a home.

This allows their children to skip the traditional bank and get a loan from their parents or grandparents.

However, many parents don’t realize these loans can impact their estate.  Or realize these loans can also be an estate planning tool.

How a Loan Impacts Your Estate Plan

The money you lend to other people is an asset. 

Your executor or successor trustee is under a legal requirement to collect the outstanding obligations – even if the borrower is a family member.

If the amount of money that you have lent out is significant — and “significant” can be relative — it is important to let your estate planning attorney about the loan to help plan your estate.

If you wish to forgive the debt,  there are special terms that must be included in your trust or will for this to happen.

Or you may want the borrower to use their inheritance to repay the loan.  Your estate planning must address this scenario.  

Lending as an Estate Planning Tool

Loans are a smart estate planning tools for families if the loans are correctly structured and well documented.

There are many benefits to the lenders (grandparents or parents): 

  • loans can essentially give access to an inheritance without any immediate gift or estate tax problems, 
  • loans can generate a better return on their cash than they could with bank deposits, and
  • borrowers (usually children or grandchildren) can take out loans at interest rates lower than commercial rates and with better terms.

Also, the Internal Revenue Service allows borrowers who are related to one another to pay very low rates on intra-family loans.

Lastly, the total interest paid on these types of transactions over the life of the loan stays within the family.

If appropriately structured and appropriately, intra-family loans may effectively transfer money within the family, for the purchase of a home, the financing of a business, or any other purpose.

These loans are a sophisticated estate tax planning strategies as a way to shift assets into special estate-tax saving trusts. These intra-family loans help families across the wealth spectrum and are often used for home improvement, an automobile purchase, or a business. 

There are several points to keep in mind regarding these types of loans:

  • the loan must be well-documented,
  • lenders should usually ask for collateral,
  • the lender should make sure the borrower can repay the loan, and
  • the income and estate tax implications should be examined thoroughly.

Next Steps

If you or someone you know has lent money to a family member, you should contact an estate planning attorney see how the loan could affect your estate plan and discuss your options.  

3 Ways Not to Leave Property for Your Children

Estate planning offers many ways to leave your property to your children, but it’s just as important to know what not to do.

Here are some things that are all-too-common, but textbook examples of what not to do or try.

Oral Wills

If you feel you have a good rapport with your family or don’t have many assets, you might be tempted simply to tell your children or loved ones how to handle your estate when you’re gone.

However, even if your family members wanted to follow your directions, it may not be entirely up to them.

Without a written document, any assets you own individually must go through probate, and “oral wills” have no weight in court.

It would most likely be up to a judge and the intestate laws written by the legislature, not you or your desired heirs, to decide who gets what.

Joint tenancy is one strategy not even to try.

Joint Tenancy

Instead of setting up a trust, some people name their children as joint tenants on their properties.

The appeal is that children should be able to assume full ownership when parents pass on while keeping the property out of probate.

However, this does not mean that the property is safe; it doesn’t insulate the property from taxes or creditors, including your children’s creditors if they run into financial difficulty.

Their debt could even result in a forced sale of your property.

There’s another issue.

Choosing this approach exposes you to otherwise avoidable capital gains taxes.

Here’s why.

When you sell certain assets, the government taxes you. But you can deduct your cost basis—a measure of how much you’ve invested in it—from the selling price.

For example, if you and your spouse bought vacant land for $200,000 and later sell it for $315,000, you’d only need to pay capital gains taxes on $115,000 (the increase in value).

However, your heirs can get a break on these taxes if you use a trust.

For instance, let’s say you die, and the fair market value of the land at that time was $300,000.

Since you used a trust rather than joint tenancy, your spouse’s cost basis is now $300,000 (the basis for the heirs gets “stepped-up” to its value at your death).

So, if she then sells the property for $315,000, she only has to pay capital gains on $15,000, which is the gain that happened after your death!

However, with joint tenancy, she does not receive the full step-up in basis, meaning she’ll pay more capital gains taxes.

Giving Away the Inheritance Early

Some parents choose to give children their inheritance early–either outright or incrementally over time.

But this strategy comes with several pitfalls.

First, if you want to avoid hefty gift taxes, you are limited to giving each child $14,000 per year. You can give more, but you start to use up your gift tax exemption and must file a gift tax return.

Second, a smaller yearly amount might seem more like current expense money than the beginnings of your legacy, so they might spend it rather than invest.

Third, if situations change that would have caused you to re-evaluate your allocations, it’s too late. You don’t want to be dependent on them giving the cash back if you need it for your own needs.

Shortcuts and ideas like these may look appealing on the surface, but they can do more harm than good.

Consult with an estate planner to find better strategies to prepare for your and your families’ future.



3 Simple Ways to Avoid Probate Costs

The bad news: probated estates are subject to a variety of costs from attorneys, executors, appraisers, accountants, courts, and state law. Depending on the probate’s complexity, fees can run into tens of thousands of dollars.

The good news: probate costs can be reduced by avoiding probate. It’s really that simple.

Here are three simple ways to avoid probate costs by avoiding probate:

Name a Beneficiary

The probate process determines who gets what when there is no beneficiary designation. So, naming a beneficiary is the easiest way to avoid probate. Common beneficiary designation assets include

Life insurance
Retirement Plans

Create and Fund a Revocable Living Trust

A revocable living trust owns your property, yet you remain in charge of all legal decisions until your death. After your death, your named trustee manages your assets – according to your A trust works well if properly created and funded by an experienced estate planning attorney.

Own Property Jointly

Probate can be avoided if the property you own is held jointly with a right of survivorship. There are several ways that you can establish joint ownership of property such as:

Joint tenancy with right of survivorship – ownership simply transfers to other tenants upon your death;
Tenancy by its entirety – is a form of joint tenancy with right of survivorship, but only for married couples in some states;
Community property – property obtained during a marriage in some states;

State laws play an important role here.

How to Avoid Sending Your Loved Ones (and Assets) through Probate

Many people are using a revocable living trust instead of a will or joint ownership as the foundation of their estate plan. When properly prepared, a living trust will avoid the public, costly and time-consuming court processes of conservatorship or guardianship (due to incapacity) or probate (after death).

Still, many people make a big mistake that sends their assets and loved ones right into the court system: they fail to fund their trust.

What Does it Mean to Fund Your Trust?

Funding a trust is simply the process of transferring assets from your name into your trust. You should also change most beneficiary designations to your trust.

Funding is accomplished in several different ways:

  • Changing the title of the asset from your individual name (or joint names if you’re married) to the name of your trust – for example, from John Smith to John Smith, Trustee of the John Smith Living Trust dated December 1, 2015.
  • Assigning your interest in an asset without a title (such as artwork, jewelry, collectibles or antiques) to your trust.
  • Changing the primary or contingent beneficiary of the asset to your trust.

What Happens to Assets Left Out of Your Trust?

For many people avoiding conservatorship or guardianship and probate are the main reasons they set up a revocable living trust. Unfortunately, you may believe that once you sign your trust agreement, you’re done. But if you fail to take the next step to change titles and beneficiary designations and then become mentally incompetent or die, your assets and loved ones will end up in probate court.

Which Assets Should, and Should Not, Be Funded Into Your Trust?

In general, you will probably want to fund the following assets into your trust:

  • Real estate – homes, rental properties, vacant land and timeshares
  • Bank and credit union accounts – checking, savings, CDs
  • Safe deposit boxes
  • Investment accounts – brokerage, agency, custody
  • Notes payable to you
  • Life insurance – if you don’t have an irrevocable life insurance trust
  • Business interests
  • Intellectual property
  • Personal effects – artwork, jewelry, collectibles, antiques

On the other hand, you will probably not want to fund the following assets into your trust:

  • IRAs and other tax-deferred retirement accounts – only the beneficiary should be changed
  • Incentive stock options and Section 1244 stock
  • Interests in professional corporations
  • Foreign assets – in some countries funding an asset into a U.S.-based trust causes adverse tax consequences, while in other countries trusts aren’t recognized or are ignored due to forced heirship laws
  • UTMA and UGMA accounts – your minor grandchild is the owner, not you as the custodian; instead, name a successor custodian

It’s important to work closely with your attorney to determine what should go into your trust and what should stay out.  Also, before purchasing new assets, consult with your attorney to find out how to title the account or deed or who to designate as the beneficiary.

What Are the Benefits of Funding Your Trust?

Funding your trust makes it possible to obtain the best results from your trust-based estate plan:

  • Your incapacity trustee instead of a conservatorship or guardianship judge will take control of your trust assets if you become mentally incompetent.
  • Your settlement trustee instead of a probate judge will take control of your trust assets after your death.
  • Your trust will be easier to update as your wishes and circumstances change instead of doing things piecemeal through joint ownership, payable on death or transfer on death accounts, or individual beneficiary designations.
  • Your final wishes will remain a private family matter instead of being publicized in the local probate court records.
  • Your incapacity or settlement trustee will have direct access to your trust assets without the need for obtaining a court order.
  • Your incapacity or settlement trustee will be able to manage, invest, sell and reinvest your trust assets without court intervention.

The Bottom Line on Trust Funding

Many people like the cost and time savings, plus the added control over assets a living trust offers. Yet in the end an unfunded trust isn’t worth the paper it’s written on.

Want to Give the Kids an Early Inheritance?

If you’re thinking about giving your children their inheritance early, you’re not alone.

A recent Merrill Lynch study suggests that nearly two-thirds of people over the age of 50 would rather pass their assets to the children early than at their death.   Whether its to help them start a new business or help them buy their first home. It can be especially satisfying to help fund your children’s dreams while you’re alive to enjoy them.  There’s no real financial penalty for doing as long as you structure the arrangement correctly.

Here are four important factors to take into account when planning to give an early inheritance.

1.  Keep the tax codes in mind.

The IRS doesn’t care whether you give away your money now or later—the lifetime estate tax exemption as of 2016 is $5.45 million per individual, regardless of when the funds are transferred. So, whether you give up to $5.45 million away now or wait until you die with that amount, your estate will not owe any federal estate tax (although remember, the law is always subject to change). You can even give up to $14,000 per person (child, grandchild, or anyone else) per year without any gift tax issues at all. You might hear these $14,000 gifts referred to as “annual exclusion” gifts. There are also ways to make tax-free gifts for educational expenses or medical care, but special rules apply to these gifts. Your estate planner can help you successfully navigate the maze of tax issues to ensure you and your children receive the most significant benefit from your giving

2.  Gifts that keep on giving.

One way to make your children’s inheritance go even farther is to give it as an appreciable asset. For example, helping one of your children buy a home could increase the value of your gift considerably as the house appreciates in value. Likewise, if you have stock in a company that is likely to prosper, gifting some of the stock to your children could result in greater wealth for them in the future.

3.  One size does not fit all.

Don’t feel pressured to follow the same path for all your children in the name of equal treatment. One of your children might prefer to wait to receive her inheritance, for example, while another might need the money now to start a business. Give yourself the latitude to do what is best for each child individually; just be willing to communicate your reasoning to the family to reduce the possibility of misunderstanding or resentment

4. Don’t touch your retirement.

If the immediate need is great for one or more of your children, resist the urge to tap into your retirement accounts to help them out. Make sure your future is secure before investing in your children’s. It may sound selfish in the short term, but it’s better than possibly having to lean on your kids for financial help later when your retirement is depleted.

Giving your kids an early inheritance is not only feasible, but it also can be highly fulfilling and rewarding for all involved. That said, it’s best to include a trusted financial advisor and an experienced estate planning attorney to help you navigate tax issues and come up with the best strategy for transferring your assets.