Increased accessibility to higher education. Evolving technological and medical sciences. Growing private companies. Greater entrepreneurial opportunities. Robust capital markets...and let’s face it, many local companies such as Facebook, Tesla, Apple, Visa, Genentech, LinkedIn, Google, Gilead and Twitter have enriched many of their employees.
These are just some of the reasons why many Americans (especially those in the San Francisco Bay Area) have more money than their parents. Other reasons include issues our parents have faced, such as loss during the economic downturn and improper retirement income planning. But no matter the reasons, a discrepancy in income between parent and child can be a complex and sensitive issue.
If your parents have approached you regarding a loan, or if you’ve simply noticed that they need financial help and want to offer assistance, it’s important to be cautious when mixing family and finances. This does not mean you should not help your parents, it only means that you should take the time to think things through before acting. Consider the following six tips when deciding if or how you should lend your parents (or other family members and close friends) money:
Determine what you are capable of lending.
It’s understandable that when your parents are facing hardships, you want to help. But if lending them money could potentially put your own finances at risk, its best to find another way to help, like contributing your time. It’s important that you never gift or loan more money than you can afford to lose. (If you are considering lending or gifting more than $14,000 in 2016, be sure to speak with your accountant as there may be tax implications.)
Decide if your contribution is a gift or a loan. Then, put it in writing.
It is key that both you and your parents (as well as any other involved parties, such as spouses) are on the same page about this money. If it is a loan, it is essential that there is a written agreement between both parties that outlines the amount of the loan and the repayment plan (including a start date, interest terms, and the expected amount and schedule of payments). Creating documentation will help to ensure all parties are properly informed about the details of the loan in an attempt to minimize misunderstandings. Even if you’ve agreed to gift the money to your parents, it is advisable to put this in writing. In the event of divorce, this may help to document how you and your spouse agreed to allocate community property.
Understand your investment.
Knowing where your money is going is important, even if you’re not the one spending it. Find out how your parents intend to use your money. Whether it’s a major purchase (like a vehicle), the down payment on a home or debt consolidation; don’t invest in something that you wouldn’t put money toward for yourself. The whole process of lending money is much easier when both parties feel comfortable and confident in the transaction.
Determine how to distribute the money.
If your parents are struggling with money management, it may not be best to hand over your gift or loan in one lump sum. Consider instead sending money in installments or paying their bills directly. Your parents may feel as if they are now the children, and you the parent. As they have almost certainly said to you before, “it’s for your own good.” Whatever you decide, be sure to make a note of it in your formal written agreement.
Encourage your parents to review their finances.
It’s important that your parents take the necessary steps to build a balanced budget and possibly get their finances back in order. At this point, it may be best to refer your parents to a professional financial advisor. Keep in mind that if you work too closely with them on this, you may judge them on their spending and saving habits, and a unnecessary strain could be placed on your relationship.
Keep open lines of communication and be honest.
Let your parents know how lending or gifting them money makes you feel, and find out how your parents are feeling. Discuss worst case scenarios concerning late payments or a default. Determine if you are willing to amend the terms of the loan, if the need arises. Share the news of the gift or loan with anyone who may need to know, including other family members, financial advisors and accountants. In some cases, it may be necessary that your parents know that this is a one-time gesture. It is important that they see you as their child, not a bank.
Final Suggestion: After all the financial talk is done, take time to do something fun together as a family. Strong family ties can help both you and your parents get through hardships of all kinds...or to celebrate that you are in such a unique position to help those you love.