While it's natural to want to provide financial help to the people we care about the most, TIAA Wealth Planning Strategies Director, Colleen Carcone, CFP®, cautions that you want to make sure your own situation is secure first, especially if you're retired.
5 smart ways to provide financial help to family members
Is your own situation secure?
Carcone says there's a reason that flight attendants emphasize the need to put your own oxygen mask on first, before trying to help others during an inflight emergency. "This situation is no different," she added. "You want to make sure that providing financial help to family members is not going to jeopardize your own financial health."
For those seeking to help family members or other loved ones, Carcone recommends meeting with your advisor before deciding on a particular action or strategy. "We talk to clients all the time who are seeking to help family members facing difficult financial situations, from unanticipated medical bills, to high tuition costs and crippling student loan debt, among others," Carcone said. "We want to look at the impact that helping loved ones will have on your own planning needs and goals. For example, is this a one-time, temporary need, or does your family member require longer-term support? Our advisors have the skills and planning tools to perform this analysis and provide those results in real time."
"We want to look at the impact that helping loved ones will have on your own planning needs and goals."
Deciding 'how' and 'how much' to help family members
One of those tools is the TIAA asset location worksheetOpens PDF, which organizes assets by account types. This helps to ensure each asset has a purpose in your overall financial plan and you're using smart strategies to help reduce the impact of taxes and market volatility. "This is an especially useful tool for helping to determine which giving strategies can best meet your needs, as well as your recipient’s needs," Carcone said.
Scenario planning also plays an important role. "By modeling different scenarios, we're able to illustrate how giving different mounts of money—either one time, or over a period of time—impacts your goals and planning," Carcone said. "That's really important for making confident and informed decisions."
How you give is also important
Finding the right balance between providing assistance and maintaining your own safety net is especially critical for those in or nearing retirement. Carcone emphasizes the importance of making sure you're not over-extending yourself, especially during periods when portfolio values may be impacted by ongoing volatility in the financial markets. "Once you determine that you are well-funded, you will want to think through which assets are best to give. For example in times of market volatility, you might not want to have to sell investments that have dropped in value," she said. "In certain situations, if you can gift low-cost basis stock, it may make sense to gift appreciated stock. But you really want to work closely with your advisor when making these decisions."
Below, Carcone discusses five smart, tax-efficient strategies for providing financial help to family members in times of need.
1. Annual gifts
2. Appreciated securities
In certain cases, gifting can be enhanced by giving appreciated stock rather than cash. That's because your gift is based on the fair market value of the asset you transfer, so you won't have to pay capital gains tax on that appreciation.
For example, if you purchased a share of stock for $1 dollar several years ago and it's valued at $100 per share today, if you sold it, you would realize a gain of $99. That's the difference between your cost-basis—the original price you paid—and the sale price. Your $99 gain would be subject to the capital gains tax. If you gave that same stock to a family member that was in a lower income tax bracket, the capital gains tax that he or she might have to pay on the sale may be less. In that scenario, the recipient of the shares, who is presumably in a lower tax bracket, would be responsible for paying any tax due when the stock is sold.
3. Direct payments to educational institutions and medical providers
As college costs continue to rise, tuition bills and student loan debt continue to mount. Those seeking to help students or their parents offset education expenses can take advantage of the exemption for direct payments to educational institutions.
"For example, if you want to help pay for a grandchild's college tuition, instead of giving the money directly to your grandchild or through a 529 plan, you can write a check payable directly to the college or university," Carcone said. "As long as you write the check directly to the school, it is not considered a gift under the gift tax rules, so it won't count toward your $15,000 annual exclusion, or require you to file a gift tax return." The same is true if you want to help pay a family member's medical expenses. If you pay the hospital or doctor's office directly, it's not considered a gift.
It's important to understand that this provision only applies to payments made directly to educational institutions and medical service providers. "If you write the check to your grandchild, even if she endorses it over to the university, you will have made a gift to the grandchild that is subject to gift tax rules," Carcone stated.
4. Intrafamily loans
Intrafamily loans are a less-known financial planning tool that may be attractive in today's low interest rate environment. However, before you lend a family member money, make sure you understand how these loans work. There's a minimum interest rate that must be charged.
With the gift tax exemption currently at $11.7 million per individual and $23.4 million per couple, the need to make intrafamily loans has decreased for most, because parents can just give money instead. However, there are still some good reasons to use this method to transfer money from one generation to another.
Intrafamily loans typically use the Applicable Federal Rate (AFR), which is the lowest interest rate that can be charged on a loan for it not to be considered a gift. The IRS has three rate tiers for the three different "terms" of loans:
Today's low AFR makes this type of loan particularly attractive now. The current AFR table can be found at IRS.gov.1
One advantage of an intrafamily loan is that the applicable federal rate is used regardless of the creditworthiness of the borrower. "In other words, if your son with poor credit went to a bank to borrow funds, he might get turned down or have to accept an above-market interest rate to secure a loan," Carcone said.
Since intrafamily loans are not subject to underwriting, they can be made based on whatever terms you, as the lender, deem appropriate, as long as the interest rate charged is the AFR or higher and actual loan payments are made. There is also flexibility in how loans are structured. For example, it could be structured as a balloon loan with the principal due at the end. However, keep in mind that if no interest is charged, or an interest rate below the AFR is used, then the interest that should have been charged on the loan would be classified as a gift by the IRS.
During the COVID-19 pandemic, many families found intrafamily loans to be a good option for helping an adult child whose business has been impacted by the coronavirus pandemic and needs more assistance than may be available through federal government assistance program. These loans may also be useful for helping family members who have been furloughed or laid off to continue to pay bills for an extended period of time, such as a mortgage.
Since the rules governing intrafamily loans are complex, be sure to work closely with your tax and financial advisors before using this strategy to loan money to family members.
5. Legacy planning
The pandemic is a great example of how events outside of our control can impact our health, lifestyle and financial goals very quickly—and in ways we could not have imagined before. It places further emphasis on the value of financial planning during our lifetimes and after we're gone.
Throughout the pandemic, I've spoken to a number of clients who are concerned about something of this magnitude happening again during their grandchildren or great-grandchildren's lifetimes," Carcone said. "That motivated a lot of people to engage in conversations with their estate planning attorneys and wealth advisors to review their legacy plans and goals and think about ways to preserve wealth to help future generations who may face a similar crisis."
For many, trust planning provides a viable solution. "Trusts provide enormous latitude in how your wealth may be transferred to subsequent generations," Carcone said. "Basically, a trust can be established for any purpose, as long as it’s legal. So provisions can be as flexible or restrictive as you want."
"Trusts provide enormous latitude in how your wealth may be transferred to subsequent generations."
For example, you could establish a trust for your grandchild where a certain percentage of the funds held in trust are reserved for higher education purposes and the remainder for housing or other potential needs that may arise over your beneficiary's lifetime. "The bottom line is, you choose the parameters and what you want the trust to accomplish," Carcone said.
There's no question that helping the people we care about most in life is both a worthy and noble endeavor. If you're in a position to do so without derailing your own financial needs and goals, there are many strategies to help you accomplish your goals. Yet, determining which strategies may work best for you can be challenging. This is where your professional advisors, including your tax professional, estate planning attorney and TIAA wealth advisor can work together to help you develop the right strategy for your family.
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