As a mother of two, Anne Stewart has worn a lot of hats over the last twenty years. She’s been a chauffeur, a nurse, a teacher, a referee, and a cook. But nothing could prepare her for her next big role: banker.
“When my daughter went off to college, I thought that we were done,” Stewart explains. “I was almost excited for empty nesting. But then, almost every month, she started calling me asking for money to pay her rent or cover a credit card bill.”
Stewart, a single mom working two jobs, wasn’t sure how to approach this. Like many parents of young adults, she wanted to help her daughter financially and make sure she was on the right money path, but she saw how loaning money to family could make the problem worse.
The gift or loan question isn’t one to take lightly. With pros and cons for both sides, loaning money to family should be done with equal consideration of both the loaner and the recipient.
Gift or loan? How to decide what’s right for your family
Gifting money to your cash-strapped kid
The biggest consideration when deciding whether to gift money or make loans to family members starts with the amount of money being asked for and the frequency of the money requests.
Stewart’s daughter never asked for more than a couple hundred each month to subsidize her living expenses while she was away in college.
“It was just a small amount each month,” Stewart recalls. “She just needed it to get by or to fill her fridge with food. Part of me felt like I owed her that since I wasn’t paying for her college, and I would have paid for those things if she were home with me.”
Stewart’s feelings are quite common. A Pew Charitable Trust study states that 26 percent of all Americans made gifts or loans to family members to cover everyday costs of living, at an average of $1,000 a year.
With the cost of living rising while starting wages remaining stagnant, it’s much harder to live independently or even afford college life without some financial gifting here and there.
Stewart was moved to give her daughter money as an incentive to stay involved with school and family obligations.
“Giving her money came with strings attached,” she explains. “She had to come home once a month at least and work around the house. She also had to maintain a 3.5 GPA and help her younger sister with her homework whenever she needed it … I also made sure she got a job for the next semester so it wouldn’t happen again.”
Stewart guesses that without dangling a financial carrot over her broke daughter’s head and offering her chores in which she could earn her money, the pair wouldn’t be as close as they are today.
Making loans from the bank of Mom and Dad
If there is no expectation or strong feeling that you should support your child with a monetary gift, or if the amount is larger in sum, a loan from parents may be the smarter and safer option for both parties.
However, before you consider loaning money to family, there are few important details to remember.
First, whether you play lender or you wrap up your check in a box and bow, the IRS may want to hear about it. If the amount given is over $14,000 (say, paying for rent each month or helping a child with a down payment on a house), you both are required to file it on your taxes.
In addition, if the $14,000+ amount is done as a loan, you are required to charge interest on the amount. Currently, the minimum interest rate is 0.61 percent for three years, 1.22 percent for nine years, and 1.88 percent for more than nine years.
This may seem ridiculous, but loans from parents with charged interest may actually be better for both parties. Without your assistance, receiving a large personal loan could mean signing on to an interest rate between 10 and 20 percent, depending on your child’s credit score and history.
In addition, loaning (rather than gifting) means you’ll earn back a tiny return on your loan, get off the hook with the IRS, and feel more secure in the investment you’ve made.
Because tax situations are complicated, it’s best to always consult an expert before lending or giving a large sum of money. While there, discuss drafting up a formal, notarized loan document.
Loaning money to family is complicated and often gets messy. Loaning to an irresponsible person or a child who refuses to be proactive can come back to bite you, especially if you expect to see the return of your loan in time.
A contract or loan document will save you from this headache and give you the ability to take action in case a relationship falls apart. It should include interest due (and the frequency), a set-in-stone payment plan, and terms of a loan, including when you expect it to be fully paid by and the actions you will take if it is not paid back on time.
Helping your child succeed financially
Deciding between gifting or loaning money to family starts with assessing the needs of your child. If it’s a small amount used to cover a few expenses or to just get by in an emergency, a gift may be appropriate, especially if you feel the need to continue parenting past high school graduation.
However, if the money request occurs frequently, is used to build wealth, or exceeds the IRS threshold of $14,000 per year, loaning money to family (especially done with the help of an accountant and tax expert) may help you recoup your money — and keep your relationship stronger in the long run.
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