Erickson Financial Solutions Blog
Lending Money to a Family Member
Sometime in your life you may be asked to lend money to a family member – offspring or sibling. There are a few issues to consider. First, can you afford to loan the money and not get it back? Presumably whoever is borrowing the money could not get it elsewhere. If they have tried a bank and were turned down, perhaps the bank has a keener eye for success than you which suggests lending might not be a profitable idea and you may not get your money back.
But banks have been wrong before and you may wish to take a chance anyway. Now comes the issue of interest – what rate will you charge.
As long as the loan is for $10,000 or less, there won't be a problem. However, if the borrowed amount is larger and you do not charge the going rate of interest, the IRS will "impute" interest for you, based on its own assumptions. You'll end up being treated as if you had charged/earned interest, even though you hadn't, and you'll owe tax on that "phantom income" that you didn't receive.
If lending to an offspring, special rules may apply. If the loan is for $100,000 or less, the interest you will be considered to have received annually for tax purposes is limited to the amount of your child's net investment income for the year. And if that amount doesn't exceed $1,000, you can avoid taxable interest income on the intra-family loan. But the IRS may still intercede if it suspects that you're trying to dodge the tax liability.
How do you figure out what the "going rate" for interest is? It depends on several factors, including the type of loan, its length, and the interest rates in your local area. You might be able to charge slightly less than a local bank, but you can't go overboard.
What happens if you do not get paid back? The IRS could determine that the "loan" was always meant to be a gift. To avoid that problem, it's best to have an attorney draft a formal loan document. It should include the usual terms that would be found in a bank loan. For instance, the document will usually indicate:
· The amount of the loan;
· The time allowed for repayment;
· The interest rate structure;
· A description of the collateral securing the loan.
Finally, have the loan document witnessed and notarized. This is the best proof you can have if the IRS ever challenges the deal. Also, keep records showing repayments to demonstrate that the arrangement is a bona fide loan.
This article was written by Steven Erickson based upon material prepared by a professional financial journalist for Erickson Financial Solutions, LLC and is not intended as legal or investment advice.
When To Disclaim An Inherited IRA
Should you ever pass up a chance to get more money? It depends. Suppose you're in line to inherit IRA assets. When it makes sense, you might use a "qualified disclaimer" so that the assets bypass you on the way to someone else.
A disclaimer is a legal document that lets you waive your right to receive money or property from an estate. If you execute a disclaimer, it's as if you never inherited the assets. Instead, they go directly to the next people in line to receive them. In the case of an IRA, the assets typically wind up with the account's contingent beneficiaries.
Why would you do this? There are two main reasons:
1. Assuming you don't need the money, you might prefer that the assets go directly to the younger generation, usually your own kids or grandkids. You were going to give the assets to them eventually anyway, right? A disclaimer shortens the process while lengthening the time over which the beneficiaries must take required minimum distributions (RMDs) from the account. RMDs are based on the life expectancies of the beneficiaries, so the younger they are, the longer the wealth can be preserved.
2. A disclaimer may reduce a family's overall tax liability. The RMDs from IRAs generally are taxed at ordinary income rates, which go as high as 39.6%. Younger children and grandchildren are likely to pay tax at a much lower rate.
For a disclaimer to work, it has to be an irrevocable, unqualified refusal to accept property, and it must meet the following requirements:
- It must be in writing with a declaration and signature of the person who is making the disclaimer.
- It must identify the property (or the partial interest in the property) that is being disclaimed.
- It must be delivered to the party or entity responsible for transferring the assets (for example, an IRA custodian or trustee).
- The disclaimer has to be executed less than nine months after the property was transferred (or within nine months of when the disclaiming person reaches age 21, if that's sooner).
- As a result of the disclaimer, the assets must pass to the new recipients without any direction from the person making the disclaimer. You can't decide to give the money to someone other than the legal beneficiaries next in line.
This process can be technically complicated, so you'll need to work with an attorney to provide the proper language for a disclaimer, which must take into account whatever is required under state law. Also, take great care in completing any beneficiary designation forms furnished by an institution.
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