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.