Should You Lend Money to Your Adult Children?
Deciding how to approach lending money to children is no simple task. As a retiree there are many factors to consider above and beyond your default parental desire to help. And because financial decisions related to family tend to have emotional entanglements, it is important to handle this issue with tact.
Consider the questions below if you, or someone you know, are confronted with this situation.
1. Do you want to lend them the money?
Perhaps this is an obvious question, but it’s an important one that must be addressed. What does your gut say about the loan? Would it truly help your child towards financial stability and independence or would it further enable poor habits?
2. What is the purpose of the loan?
There is a difference between bailing your child out and helping them launch. The purpose of the loan will be a clear indication as to which camp they are in.
Perhaps this is your chance to pay it forward and reciprocate some good you received when you were just starting out in life. Helping with the purchase of a first home or supporting them in a solid business endeavor can be a great way to push your children forward into future successes.
3. Can you afford to make the loan?
Assuming you want to help out and you are in support of the loan’s purpose, it’s time to crunch the numbers and see if you can actually afford to make the loan.
- How would your long-term financial stability be if your child defaulted on the loan?
- Do your updated financial projections support the decision to lend the money?
- What is the opportunity cost from providing the loan? (i.e. potential loss of investment growth, etc.)
- What expenses would you incur? (i.e. transaction costs, tax ramifications related to IRA withdrawal, etc.)
4. Should you draw up a loan agreement even though they are family?
The short answer is yes. Though it may be uncomfortable, clearly outlining the terms of the loan in a formal document is an essential step. This will open up the door on the front end of the agreement for open communication and will set the expectations for both parties.
Key factors to include in the loan agreement:
- Names of all parties involved
- Amount of the loan
- Interest rate being charged
- Repayment terms and timeline
Note: take special care regarding the loan’s interest rate. The IRS has rules regarding the minimum that must be charged in order for it to be considered a loan. Otherwise the money may be considered a gift to your child, which has a different set of parameters and ramifications to be aware of.
Whatever you decide—situations involving family and money tend to be complicated. Be sure to do your homework, know your children, and approach each situation with an extra touch of care.