Part of being a member of a family is being asked for favors big and small. Will you dog-sit while I am on vacation? Will you host my baby shower? Will you put my children through college?
Clearly, requests for financial support are more substantial and complicated than other favors. Before responding, you should first assess whether you are able and willing to provide financial assistance. If so, then the question becomes how to help without damaging family relationships and incurring negative tax or estate planning consequences.
Should You Give?
When you receive a request for financial support and are uncertain whether it is financially feasible, the best answer is “I need to consult with my advisors.” An investment advisor or financial planner can help determine whether a financial commitment to a loved one is possible or prudent given your current income, investments and expenses. They will also be able to help you assess the potential impact giving could have on your financial future.
Determining whether or not you are willing to help – and to what extent – is often more difficult. As a sister, brother, cousin or in-law, you are not a dispassionate loan officer at the corner savings bank. Your feelings about how hardworking your loved ones are, the life choices they have made and how they plan to use the funds will undoubtedly color your opinion on whether you want to make the gift or loan.
It is entirely legitimate to refuse a request for financial support if you don’t support the purpose. After all, it is your money. You may also want to consider your decision’s impact on family harmony. To avoid future conflict, it can be helpful to establish ground rules about the circumstances in which support is available. For example, you may decide that you are willing to help all the nieces and nephews with tuition but that you are unable to satisfy other requests for financial help. Setting boundaries can prevent requests for help with expenses that may seem frivolous or unnecessary and gives your family a clear understanding of what you are willing to support financially.
Popular Ways to Provide Support
Once you have established that you are able and willing to help – and how much support you will provide – your advisors can assist in designing an efficient plan. There are a number of easy ways to provide financial help.
One option is to write a check or make a direct transfer. Under current law, you can give up to $14,000 per year free of gift tax to an unlimited number of individuals. For example, if you have four nieces and nephews, you may give $14,000 to each of them in 2016, for a total of $56,000 in gifts. Married couples can combine their annual exclusions and give up to $28,000 per year to an unlimited number of beneficiaries without paying gift tax or using any of their lifetime estate tax exemption. In the example above, the potential gifts could total $112,000. With large extended families, annual exclusion gifts can add up fast.
For gifts in excess of $14,000, you must either use a portion of the $5.45 million gift tax exemption or, if exhausted, pay the federal gift tax at the current rate of 40%. Neither are generally efficient alternatives for wealthy individuals who have estates substantial enough to incur estate tax.
An intrafamily loan may be a good option when a family member needs quick access to significant funds for an emergency or other immediate expense. You can transfer money to an individual and take back a promissory note at a low rate (i.e., the applicable federal rate). The exit strategy for the loan is either repayment at a more convenient time or forgiveness over time.
Tuition and medical expense payments
Federal tax law exempts from gift tax tuition payments (but not books, room and board and other incidental expenses) directly to an educational organization as well as the payment of medical expenses and medical insurance directly to a provider.
If these straightforward methods do not serve your purposes or are not tax efficient due to the size and extent of your financial assistance, the use of trusts may be a solution.
If you want an independent third party to make decisions about which needs and family members should take priority, or if you simply want to put some distance between you and the person receiving the money, a trust may be appropriate. Trusts come in many shapes and sizes – Crummey, grantor, non-grantor, irrevocable and revocable, to name just a few. A Brown Brothers Harriman (BBH) wealth planner can assist you with the details of how your family trust should be designed to best fit your and your family’s needs.
Grantor retained annuity trusts (GRATs) and sales to grantor trusts
GRATs and sales to grantor trusts are both methods to transfer the future appreciation on certain assets to family members or to trusts for their benefit without the use of the gift tax exemption. It is appropriate to explore these options if you want to make gifts in excess of the annual exclusion and have limited gift tax exemption available for this purpose.1
How to Give in a Fair and Equitable Way
By far the most complicated issues when it comes to providing financial support relate to equality and fairness and how to preserve healthy family relationships.
In families where one sibling or sibling-in-law has been very successful, there is often great disparity in wealth, which can lead to requests for help from various family members. In this situation, challenges may arise when multiple family members ask for support and the wealthy individual makes distributions on a case-by-case basis. Again, even in the case of very substantial wealth, ground rules can be helpful in establishing boundaries.
If equality is important to you, here are a couple of useful strategies:
- Instead of making an outright gift, consider structuring the transaction as a loan at a low interest rate. The loan could be repaid in the future, if circumstances change, or it could be forgiven under your estate plan.
- If you intend to leave money to each of your siblings or other relatives, you could “advance” that inheritance to those who have an immediate need with the understanding that it will decrease the amount they will receive under your estate plan.
- Create a family trust and allocate a certain amount to the trust, and then allow an independent trustee to assess need, fairness and timing of distributions. This is a useful tool for avoiding uncomfortable situations, such as having to write a check to a sibling to cover living expenses. The trustee (for example, a bank, attorney or accountant) can distribute funds on an annual basis, which creates some distance between the person providing assistance and the family member receiving help.
- Having the means to provide financial assistance to family members can be both a burden and a blessing. It can strain or damage family relationships if you are not thoughtful in your response and consistent in your approach.
- The good news is that there are many options for providing financial support, and your BBH relationship manager or wealth planner can help you devise a plan that meets your goals while preserving family harmony.
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1 More information on GRATs and sales to grantor trusts is provided in our third quarter 2015 Owner to Owner article, “Transferring Future Appreciation on Business Interests to Beneficiaries: A Discussion of Grantor Retained Annuity Trusts and Sales to Grantor Trusts.”