Should You Become the Bank of Mom and Dad?

One out of five American adults have financially helped one of their adult children (or an elderly parent) over the past year, according to a study of consumer financial habits by a leading investment advisory firm. The financial help may come in the form of a gift or may be a loan from the "Bank of Mom and Dad."

Deciding to open your checkbook — or not — to your adult kids is a personal choice. But keep in mind that mixing family and finances can get tricky, particularly if it's a significant amount of money. To keep your family intact and your financial future safe, consider these points before agreeing to lend money.

Be sure you can afford it. Financial experts say to lend only as much money as you can afford to lose if you're never paid back. You don't want to jeopardize your own ability to pay your bills or invest for retirement, nor do you want to risk damaging an important relationship.

Get professional advice. Part of determining whether you can afford a loan is having your trusted advisors look over your resources, particularly if the loan amount is substantial. You might also need to consult an attorney. A legal professional can help ensure that your loan documents are prepared correctly and that you've carefully considered all legal aspects of the agreement.

Find out if the loan could trigger taxes. If you don't charge interest on a loan of more than $15,000, the IRS may consider the amount to be a gift. If that happens, your borrower may have to report the gift and pay tax on it and you may have to file a gift tax return.

Be businesslike about the process. Once you've decided to make a loan, you need to formalize it. You can get a simple loan agreement form at an office supply store or online. The form should include all loan terms:

There's a chance your borrower will protest the formality of a contract. But remember, it's your money and your future. Keeping the loan businesslike protects everyone.

Update your will. If you lend more than a few thousand dollars to one child, make sure you're being fair to any other children. Leave copies of the written loan agreement with your will and consider updating your will to incorporate the loan.

Suppose by the time you pass away, the child who borrowed the money hasn't yet paid off the loan. Your will can do two things: forgive the loan or designate the balance of the loan as the borrower's first share of any inherited money. This way, your other kids aren't penalized just because one of their siblings has an unpaid loan on the books.

Don't Rush

Whatever you decide, take time to check with a financial or legal professional, if not both. Lending money is a personal decision but you should make that choice only after you know what you're getting into, in terms of your own financial future and possible taxable transactions.

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