Print

Email story

Comment

Email editor

Columns

Loaning to loved ones? Be ready for risks

By HELEN HUNTLEY
Published January 14, 2007

If you've ever felt like you were running the Bank of Mom and Dad, this column is for you.

Lending money to family members or friends is a popular way to share your resources with those you care about, but it takes you down a path fraught with peril. An unpaid loan can ruin a treasured relationship.

The first rule of lending to those you love is to start out grounded in reality, recognizing that your loan may not be paid back no matter how many promises the person has made. Private loans between individuals have a 14 percent default rate, according to Circle Lending, a Boston loan administrator. Loans to help start a new business are particularly risky.

The risk means you should never lend money you could not afford to turn into a gift. You should consult with anyone who would be affected, such as your spouse, if the loan is not paid back. You might even consider making a gift in response to a request for a loan, especially if you doubt that the person will make payments as promised.

Any loan should be handled in a businesslike way that makes your expectations clear. You need a written loan agreement outlining the interest rate, payments, penalties for late payment and other terms. A monthly payment plan is better than a promise to repay a lump sum. Promissory note documents are available on Web sites such as www.lawdepot.com Have your document notarized.

Larger loans involve special considerations, including security if you can get it. When appropriate, a loan might be secured by a mortgage on real estate or a lien on the title of the car.

You might consider using a third party, such as Circle Lending (www.circlelending.com), to set up the loan and process payments electronically. That's a way to separate the business of the loan from your personal relationship.

If repayment becomes difficult for your borrower, you might agree to restructure the debt or forgive some interest payments. If it turns out you are not going to be paid, you may have an income tax deduction for a non-business bad debt. However, the IRS considers loans among family members to be gifts until proven otherwise. Handing the loan in a businesslike fashion and making efforts to collect will help you establish your case.

Your questions

Must E or EE bonds be cashed when they reach final maturity or can they just be left to heirs without cashing them even though they no longer earn interest? Is there any tax penalty if you wait to cash them?

Technically the tax is due when the bond reaches maturity, but you won't get a 1099 form reporting the interest until you cash the bonds. Although there is no tax penalty, what you are proposing is a bad idea. In addition to sticking your beneficiaries with the tax bill, you're making an interest-free loan to the government in the interim. Why not cash the bonds and use some of the proceeds to pay the taxes?

My wife and I are in our 80s, own our home and have about $160,000 in savings. A financial adviser wants to put $70,000 in an annuity, but we don't know much about this. Is it a reasonable investment at our age?

No. I don't know the terms of this annuity, but it probably involves locking up your money for at least a few years with hefty surrender penalties. If it's yield you're after, you would be better off with a high-yielding money-market account. If you need additional income, it's okay for people in their 80s to spend some of their principal.

Is the lifetime gift tax exemption $1-million each for a husband and wife ($2-million total) or could we each give $1-million to each of our four children ($8-million total)?

A: It's $2-million total. And if you have that much money, you need to be talking to an experienced estate planning lawyer.

Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, write hhuntley@sptimes.com or Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731. Read more questions and answers at blogs.tampabay.com/money.

[Last modified January 14, 2007, 06:08:12]