Family loan as a form of wealth transfer?

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010101
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Family loan as a form of wealth transfer?

Post by 010101 »

Mid-forties with a 21 month old child. Assets approaching $10M.

With interest rates where they are, I’m wondering if it’s possible to do a family loan with our son (21 months old) for $1M for investing purposes. We would do things above board, pay taxes on the interest, have a contract (that yes, he can’t read or sign at the moment), etc. The goal is that over 20 years, this $1M could turn into $5M. Doing a loan also means that we wouldn’t eat into our lifetime gift exclusion. Finally, the paperwork and hassle seem minimal.

Some people might say, “why not a trust?” And I don’t think that’s ruled out. This is more of a “this seems easy right now” kind of thing and can be done in addition to a trust.

Does this seem legit to people? I hear people do family loans with older children all the time but I’ve never heard people loan their children <18 years any money.
123
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Re: Family loan as a form of wealth transfer?

Post by 123 »

An individual cannot sign a valid contract (loan agreement) until they are 18 years of age. There are some exceptions for contracts for essential items (food, medical care, etc) but a loan for investment purposes doesn't seem to fit those.
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bampf
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Re: Family loan as a form of wealth transfer?

Post by bampf »

Hi and welcome to the forum. In my opinion you are starting to get into the kinds of stuff that a lawyer and or tax attorney should be advising you on. I would imagine a loan to your kid, when your kid can't sign but you can sign on his behalf will start to look like you are dodging, but, honestly I don't know enough to know what I don't know.

With assets like this, I think you want a long term strategic plan. If you are doing it to avoid the gift exclusion, you are perhaps making some mistakes up front. In 20+ years that 10M could easily be 30M or 40M and you are now talking multi generational wealth and you want the right people giving you advice.

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AlohaJoe
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Re: Family loan as a form of wealth transfer?

Post by AlohaJoe »

010101 wrote: Sat May 15, 2021 11:27 pm have a contract (that yes, he can’t read or sign at the moment), etc.
This should be your hint that your plan is silly. Infants can't sign contracts. Pretending he agreed to the loan is.... :oops:
bogcir
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Re: Family loan as a form of wealth transfer?

Post by bogcir »

I think all paths lead to a trust. You should be looking at that anyway before the exemption goes down.

There are ways to structure loans to trusts but it’s a bit complicated it seems and not quite as straightforward. There could be better ways depending on your individual circumstances.

https://www.wealthspire.com/guides-whit ... ily-loans/
michaeljc70
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Re: Family loan as a form of wealth transfer?

Post by michaeljc70 »

How will an infant pay the interest? With his allowance? You would have to record the interest as income. What tax bracket are you in? I think there are a lot of problems with this idea and I'd consult a lawyer that specializes in trusts/estates.
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TomatoTomahto
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Re: Family loan as a form of wealth transfer?

Post by TomatoTomahto »

Don’t let the tax tail wag the dog.

Our kids are older, but we gift to the annual max annually ($30k/child), in one case via a Crummey trust. That seems like a drop in the bucket, but every year we take $120k (4 kids) out of our estate, which does add up.

In 20 years, that would be $600k plus growth.
I get the FI part but not the RE part of FIRE.
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Watty
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Re: Family loan as a form of wealth transfer?

Post by Watty »

010101 wrote: Sat May 15, 2021 11:27 pm ....this $1M could turn into $5M.
Or it could turn into $100K but he would still have a million dollars in debt. I really doubt that putting your kid into debt like that is allowed.

As others have said you really need expert estate tax planning.

To me a bigger problem though is that there is a risk that when he turns 18 and gets unfettered access to money he might not be responsible enough to manage it. Having money like that at 18 is also likely to attract all sorts of dubious "friends" and girlfriends.

He could also be experimenting in things like drugs or alcohol and handing him a couple of million dollars at the wrong time could cause huge problems. It did not involve money like that but I have heard of several apparently good middle class families with kids that ended up homeless, in jail, or dead of an overdose because of drugs. Don't think that just because you are well off that you are immune to that.
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willthrill81
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Re: Family loan as a form of wealth transfer?

Post by willthrill81 »

If it was possible to make a huge loan to your child, someone else would have already thought of it.

Talk to a recommended estate planning attorney in your state. A trust is likely the way to go.
Last edited by willthrill81 on Sun May 16, 2021 9:12 pm, edited 1 time in total.
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TomatoTomahto
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Re: Family loan as a form of wealth transfer?

Post by TomatoTomahto »

Watty wrote: Sun May 16, 2021 10:06 am To me a bigger problem though is that there is a risk that when he turns 18 and gets unfettered access to money he might not be responsible enough to manage it. Having money like that at 18 is also likely to attract all sorts of dubious "friends" and girlfriends.
I think that no reasonable estate attorney would suggest anything but a trust.

For much smaller amounts, we used a UTMA and then depleted it during college. I would not consider doing so in a state where the UTMA Account Age of Majority is lower than 21, but that’s me. For some states, it’s still 18.

For our spendthrift adult, we use a Crummey trust.
I get the FI part but not the RE part of FIRE.
Gill
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Re: Family loan as a form of wealth transfer?

Post by Gill »

As others have suggested, your attempt to lend money to an infant is a total sham. Infants (under the age of majority) have no power to enter into contracts including borrowing money. You need to discuss your wishes with an experienced trusts and estates attorney.
Gill
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motiv8ed
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Re: Family loan as a form of wealth transfer?

Post by motiv8ed »

OP,

Yes, what you're asking about is done all the time and is perfectly legal.
010101 wrote: Sat May 15, 2021 11:27 pm I’m wondering if it’s possible to do a family loan with our son (21 months old) for $1M for investing purposes. We would do things above board, pay taxes on the interest, have a contract (that yes, he can’t read or sign at the moment), etc. The goal is that over 20 years, this $1M could turn into $5M. Doing a loan also means that we wouldn’t eat into our lifetime gift exclusion. Finally, the paperwork and hassle seem minimal.
This Barron's article is 6 years old, but gets the point across pretty well. In addition to other examples, it give this one:
Let’s assume an aging millionaire funds a trust for his children’s benefit. He seeds the trust with a $100,000 gift, and then loans it $900,000 at the allowable 1.82% interest rate for five years, which, we’ll assume, the trust invests wisely. The trust makes regular payments on the loan, and then repays Daddy Warbucks his principal in full at the term’s end. Any investment gains over that extremely low interest rate stays tax-free in the trust for the next generation. “It’s all legal, and all great planning for the client,” says Mela Garber, chair of the trust and estates group at accounting firm Anchin, Block & Anchin.

Happy investing!

motiv8ed
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Scott S
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Re: Family loan as a form of wealth transfer?

Post by Scott S »

If this plan succeeds, your kid will be rich enough he'll never have to work. Does your family have grand plans for what he'll do with his life instead?
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010101
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Re: Family loan as a form of wealth transfer?

Post by 010101 »

Thanks for the replies. It's clear that this setup needs the right amount of paper to be legit.

From here: https://www.barrons.com/articles/how-fa ... 1443243701
So when you’re planning your wealth transfer, think about pairing a loan and a trust
It's amusing to me that I can't loan a family member money. But I can create a trust with the family member designated as a beneficiary and then loan the money to the trust. I can't do A=>C but A=>B=>C is totally legit...
hachiko
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Re: Family loan as a form of wealth transfer?

Post by hachiko »

I don't understand. What's the purpose of the loan? Why not just gift $1m now?

Also, there are already so many methods of transferring wealth. Various types of trusts and FLPs are tried and true (as long as you don't go overboard - bears make money, bulls make money, pigs get slaughtered). Why are you trying to do something new?
ajcp
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Re: Family loan as a form of wealth transfer?

Post by ajcp »

010101 wrote: Sun May 16, 2021 10:48 pm It's amusing to me that I can't loan a family member money. But I can create a trust with the family member designated as a beneficiary and then loan the money to the trust. I can't do A=>C but A=>B=>C is totally legit...
Babies can't take out a loan. There's no reason babies can't be beneficiaries. I find it odd that you don't see how monumentally different those two things are.
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RickBoglehead
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Re: Family loan as a form of wealth transfer?

Post by RickBoglehead »

010101 wrote: Sun May 16, 2021 10:48 pm Thanks for the replies. It's clear that this setup needs the right amount of paper to be legit.

From here: https://www.barrons.com/articles/how-fa ... 1443243701
So when you’re planning your wealth transfer, think about pairing a loan and a trust
It's amusing to me that I can't loan a family member money. But I can create a trust with the family member designated as a beneficiary and then loan the money to the trust. I can't do A=>C but A=>B=>C is totally legit...
You can loan a family member money, and at below market rates (specified by the IRS), as long as the person you loan the money to can legally sign the loan agreement. Since a baby can't do that, you can't loan a baby money. Pretty simple.

In the trust, the baby is a beneficiary. The trust has trustees, that have a fiduciary duties - a duty of loyalty, a duty of prudence, and subsidiary duties. The trust has to be administered solely in the interest of the beneficiaries. The trustee is held to a standard of care in administering the trust property.

So, in short, the trustee looks out for the baby, NOT the parent who is looking to transfer wealth and reduce / avoid taxes. If the parent is both the person providing the loan and the trustee, they need to make sure they do everything required as a trustee.
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TomatoTomahto
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Re: Family loan as a form of wealth transfer?

Post by TomatoTomahto »

hachiko wrote: Sun May 16, 2021 10:58 pm I don't understand. What's the purpose of the loan? Why not just gift $1m now?
I’ll admit that I have not thought long and hard about this, but I think $1M gift is a bad idea.

If a couple has $23M to gift right now, it might be a good idea to get it booked before estate tax changes. But, having $23M to gift means having considerably more to live on, so it’s not something most can do.

Gifting to the annual gift tax exclusion ($30k for a couple) is a no-brainer if you can afford it. 20 years of that adds up.

Gifting $1M, especially in a state like MA or other low estate threshold states, is probably not a good idea.
I get the FI part but not the RE part of FIRE.
halfnine
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Re: Family loan as a form of wealth transfer?

Post by halfnine »

TomatoTomahto wrote: Mon May 17, 2021 7:36 am
hachiko wrote: Sun May 16, 2021 10:58 pm I don't understand. What's the purpose of the loan? Why not just gift $1m now?
I’ll admit that I have not thought long and hard about this, but I think $1M gift is a bad idea.

If a couple has $23M to gift right now, it might be a good idea to get it booked before estate tax changes. But, having $23M to gift means having considerably more to live on, so it’s not something most can do.

Gifting to the annual gift tax exclusion ($30k for a couple) is a no-brainer if you can afford it. 20 years of that adds up.

Gifting $1M, especially in a state like MA or other low estate threshold states, is probably not a good idea.
As the OP is near $10M they are quite close to what existing law is set to revert to in 2026. And even that level is quite high by historical standards. Due to how fast NW can grow giving away some of it sooner than later is often a better course of action if one wants to hedge their bets. And the equivalent of gifting 30K/yr would take them 33 years to gifing $1M now. That said, gifting being a bad idea, low estate threshold states, etc. are all valid concerns.

On a side note I watched a friend's family business go from low 8 figure to a 9 figure company over a 15-20 year period. They were slow to gift shares to the next generation. Had they done it sooner rather than later it could have all fit within exemption limits. Now they have massive future tax headaches.
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Re: Family loan as a form of wealth transfer?

Post by mmcmonster »

A colleague and I were discussing whether to gift money (~30k/year) to our kids, who are going off to college. We came to the conclusion that we would not trust our kids to not dip into the money until they want to buy a home or similar.

I can't imagine what it would be like finding out when I turned 18 (or earlier) that I personally was a millionaire or (much worse) owed my parents $1M on a loan I could never have agreed to. It would certainly cloud my plans on higher education.
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Re: Family loan as a form of wealth transfer?

Post by TomatoTomahto »

mmcmonster wrote: Mon May 17, 2021 8:27 am A colleague and I were discussing whether to gift money (~30k/year) to our kids, who are going off to college. We came to the conclusion that we would not trust our kids to not dip into the money until they want to buy a home or similar.
You have to know the players. In our case, one is receiving the gifts into a trust via Crummey. The older three are receiving directly and have, as expected, used the funds appropriately.
I get the FI part but not the RE part of FIRE.
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Re: Family loan as a form of wealth transfer?

Post by hachiko »

TomatoTomahto wrote: Mon May 17, 2021 7:36 am
hachiko wrote: Sun May 16, 2021 10:58 pm I don't understand. What's the purpose of the loan? Why not just gift $1m now?
I’ll admit that I have not thought long and hard about this, but I think $1M gift is a bad idea.

If a couple has $23M to gift right now, it might be a good idea to get it booked before estate tax changes. But, having $23M to gift means having considerably more to live on, so it’s not something most can do.

Gifting to the annual gift tax exclusion ($30k for a couple) is a no-brainer if you can afford it. 20 years of that adds up.

Gifting $1M, especially in a state like MA or other low estate threshold states, is probably not a good idea.
True, but the loan just seems strange. At some point, the kid is going to have to sell investments to pay off the loan, which would, presumably, result in taxable income. So they'd pay tax on that, but now the parents have an additional $1m in the estate again. And how are they going to get that back down to the next generations? In the interim, the parents are going to be taxed on a not insignificant amount of interest, without a corresponding deduction for the kid.
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Re: Family loan as a form of wealth transfer?

Post by Gill »

hachiko wrote: Mon May 17, 2021 9:16 am True, but the loan just seems strange. At some point, the kid is going to have to sell investments to pay off the loan, which would, presumably, result in taxable income. So they'd pay tax on that, but now the parents have an additional $1m in the estate again. And how are they going to get that back down to the next generations? In the interim, the parents are going to be taxed on a not insignificant amount of interest, without a corresponding deduction for the kid.
The parents don't have an additional $1 million in the estate again. It never left. They exchanged cash for a note receivable.
Gill
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Re: Family loan as a form of wealth transfer?

Post by daektr »

010101 wrote: Sat May 15, 2021 11:27 pm (that yes, he can’t read or sign at the moment)
I think this part ruins the loan idea.
010101 wrote: Sat May 15, 2021 11:27 pm With interest rates where they are, I’m wondering if it’s possible to do a family loan with our son (21 months old) for $1M for investing purposes. We would do things above board, pay taxes on the interest, have a contract (that yes, he can’t read or sign at the moment), etc. The goal is that over 20 years, this $1M could turn into $5M. Doing a loan also means that we wouldn’t eat into our lifetime gift exclusion. Finally, the paperwork and hassle seem minimal.
Just in case it's helpful, you are basically describing a GRAT (grantor retained annuity trust). I'm setting up one of those right now, similar goal, I think.

Do consider - if the money doubles or triples in 18 years - I suspect you won't want your 18-21yo with $2m free and clear (no oversight on your part, the bank/brokerage will go out of their way to inform them of the account's existence, etc), which is what would happen with a UTMA account.
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Re: Family loan as a form of wealth transfer?

Post by hachiko »

Gill wrote: Mon May 17, 2021 9:26 am
hachiko wrote: Mon May 17, 2021 9:16 am True, but the loan just seems strange. At some point, the kid is going to have to sell investments to pay off the loan, which would, presumably, result in taxable income. So they'd pay tax on that, but now the parents have an additional $1m in the estate again. And how are they going to get that back down to the next generations? In the interim, the parents are going to be taxed on a not insignificant amount of interest, without a corresponding deduction for the kid.
The parents don't have an additional $1 million in the estate again. It never left. They exchanged cash for a note receivable.
Gill
I meant compared to if you just gift it now. In other words, the only benefit is you're removing some of the appreciation from the estate at a current (annual) cost of the tax on the AFR.
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TomatoTomahto
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Re: Family loan as a form of wealth transfer?

Post by TomatoTomahto »

hachiko wrote: Mon May 17, 2021 9:16 am
TomatoTomahto wrote: Mon May 17, 2021 7:36 am
hachiko wrote: Sun May 16, 2021 10:58 pm I don't understand. What's the purpose of the loan? Why not just gift $1m now?
I’ll admit that I have not thought long and hard about this, but I think $1M gift is a bad idea.

If a couple has $23M to gift right now, it might be a good idea to get it booked before estate tax changes. But, having $23M to gift means having considerably more to live on, so it’s not something most can do.

Gifting to the annual gift tax exclusion ($30k for a couple) is a no-brainer if you can afford it. 20 years of that adds up.

Gifting $1M, especially in a state like MA or other low estate threshold states, is probably not a good idea.
True, but the loan just seems strange. At some point, the kid is going to have to sell investments to pay off the loan, which would, presumably, result in taxable income. So they'd pay tax on that, but now the parents have an additional $1m in the estate again. And how are they going to get that back down to the next generations? In the interim, the parents are going to be taxed on a not insignificant amount of interest, without a corresponding deduction for the kid.
I should have pointed out, as others have, that the loan is a non-starter. I was assuming that a legal way to move assets to the child were being considered.

My point was that a $1M gift is a bit “neither fish nor fowl.”
I get the FI part but not the RE part of FIRE.
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Re: Family loan as a form of wealth transfer?

Post by JackoC »

Gill wrote: Mon May 17, 2021 9:26 am
hachiko wrote: Mon May 17, 2021 9:16 am True, but the loan just seems strange. At some point, the kid is going to have to sell investments to pay off the loan, which would, presumably, result in taxable income. So they'd pay tax on that, but now the parents have an additional $1m in the estate again. And how are they going to get that back down to the next generations? In the interim, the parents are going to be taxed on a not insignificant amount of interest, without a corresponding deduction for the kid.
The parents don't have an additional $1 million in the estate again. It never left. They exchanged cash for a note receivable.
Gill
True, which is why the loan idea* isn't fundamentally different from a gift purely from estate tax POV, assuming the gift is charged 100% against your estate tax exemption, there are no other gifts, and that exemption does not change. The $1mil loan is like you say always in your estate at that fixed book value, effectively taking up $1mil in estate tax exemption. In the gift case you literally reduce the exemption $1mil, that's likewise fixed. Basically the same, unless you make eg. make $X in cumulative gifts to just below a prevailing exemption of $Y, and then the exemption is cut to Y/2, Y/3 etc. in which case your exemption becomes zero not negative. In that case even gifts counted as 100% could come out ahead of loans of the same amount, purely in estate tax terms.

As they also would if using a structure (types of trust, family LLC the infant 99% owns but you solely manage, etc.) that allows the exemption reduction to be counted as less than the market value of assets gifted. That like the exemption itself is something where you should bring yourself up to speed on the current political debate. It's separate from 'consult a professional' though that's necessary too (for most of us anyway) to actually implement a complex estate tax planning maneuver. It's negligent against your own interest to not consider political dynamics and timing around possible estate tax changes. Don't discuss/debate details here, but do look it up.

*you can do something pretty similar economically as others mentioned: set up a small trust for benefit of the infant to which you make a large loan. But that obviously doesn't save the complexity of a trust. And I agree 'just make a loan' to an infant probably doesn't work, the issue of validity of a loan to non-sentient person, plus sometimes a reason to avoid trusts is that higher tax brackets kick in at much lower income (federal side) than an adult's personal tax, but kiddie tax brackets have been basically harmonized with trust brackets.
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