personal finance

Keeping the ‘Bank of Mom or Dad’ From Being Overdrawn

Of course you want to help your adult children, but don’t let that ruin your retirement, or your relationship. Here are some things to consider before lending or gifting money to your kids.

Families have been giving financial gifts or lending money for generations, but allowing adult children to continue to draw on the “Bank of Mom or Dad” can add up, potentially putting parents’ retirement plans and financial security at risk. When children become young adults – leaving home, starting a family of their own – many parents think that they will have more time and money available for their own needs when, in reality, this might be the most expensive stage of parenting.

Parents of adult children spend more than $500 billion on them per year, according to a recent study by research firm Age Wave – twice what they contribute to their own retirement accounts. And that $500 billion does not include the cost of some big-ticket items. For instance, the study further found that 6 in 10 parents help pay for their adult child’s wedding, and about 25% help fund a home purchase.

But what is the true cost to the parents? If you are not consulting with your financial adviser to understand the impact that gifts or loans to your children has on your own financial plan, the actual consequences may be more costly than you think. Most parents expect to make sacrifices for the benefit of their children, but financial sacrifices may backfire if not planned carefully. Age Wave reports that 50% of parents are willing to draw down savings, 43% would curtail their lifestyles and 25% would be willing to take on debt or make withdrawals from retirement accounts to help their adult children with money.

 The unintended consequence of these actions, however, could result in your financial plan being derailed and the parent being financially dependent on the adult children later in life, which is likely not a desired outcome for anyone in the family.

Before You Lend Your Children Money …

So how do you make sure the “Bank of Mom or Dad” isn’t overdrawn? Establishing priorities and boundaries is important to keeping both family relationships and family finances on solid foundations. Start with an open conversation about expectations of the financial assistance requested by the adult child. Is the child seeking a loan, which they expect to pay back, or an outright gift?

If a loan is put in place, here are some important points to keep in mind:

  • Get the specifics in writing. Document the payback period, the interest rate to be charged, the payment schedule and the collateral for the loan.
  • Can the adult child realistically make the agreed payments?
  • Does the parent need the monthly payments to pay for their own expenses or fund their retirement?
  • What if there are late payments or the loan goes into default?
  • Is the parent willing to foreclose on a home or take the collateral?

Not only are these important financial questions, but the relationship elements of these possibilities need to be seriously considered, too. If the parent needs the loan payment for their own living expenses, how will the adult child feel if they are not able to make the payment on time and the parent goes into debt? Would the parent be willing to foreclose on the property if the loan is uncollectible as per the payment terms?

If the loan amount puts enough strain on the parents’ finances to possibly cause either of these situations, it is reasonable to assume the risk – both financially and personally – is likely too high to consider the loan.

Going a Different Route with a Gift Instead

Outright gifts are also often made to adult children, and the parent should carefully review the impact of the gift to their future financial state. If you are considering a withdrawal from your long-term investment account or retirement account, make sure you understand the implication of the reduction of your asset base to the future value. Compound interest is a powerful tool, but a smaller present value of your assets now means less money is available to compound, making a meaningful change in your future expected lifestyle.

Under current federal gift tax rules, anyone can gift $15,000 per year to someone else without having to pay any gift tax or file a gift tax return. This is called the annual gift tax exclusion and it applies to family, friends or even a stranger. A married couple can each gift $15,000 to the same person, so parents could gift a total of $30,000 to each of their children every year. The annual gift tax exclusion of $15,000 includes all gifts in the calendar year to reach the $15,000 threshold, so make sure to include the value of any other gifting (like for a birthday or holiday) if you are considering make such a gift. 

Additionally, the federal lifetime gift tax exemption may be used when making gifts over the annual gift tax exclusion amount. For 2021, the federal lifetime gift tax exemption is $11.7 million per individual and $23.4 million per couple. As an example, a married couple is considering making a gift of $200,000 to help a child with a down payment for a home.  Assuming no other gifts are given in the calendar year, each parent would be able to gift $15,000 as the annual gift tax exclusion for a total of $30,000.  The remaining $170,000 could be claimed as using a portion of the parents’ lifetime gift tax exemption.  No gift tax would be due on the $170,000, but a federal gift tax return would need to be filed to document the gift using a portion of the lifetime exemption.

It is important to note that the gift tax rules change often, both in amount and structure, so it is critical to consult your financial and tax adviser to make sure you understand the current laws in effect before you make the gift.

Why Would You Consider a Gift Instead of a Loan? 

Most commonly, we see gifting being used to help with long-term assets, like a down payment for a first home purchase, where parents want to help their child start to build their own wealth.  Loans may be used for short-term needs, like a bridge loan when a child wants to purchase a new home but their current home has not yet sold or to help launch a business venture.  Gifts can also be advantageous if you have assets that will be subject to estate tax, as lifetime gifting can be a way for assets to moved out of your taxable estate.   

Whether you are considering a loan or a gift to an adult child, you should consult your financial adviser before deciding in order to be sure you understand the financial and tax implications. And make sure that you document your gift or loan correctly, for tax purposes as well. Your adviser will help you make an informed decision on what is the best strategy is for your family’s situation.

Parents wanting to help their children is a generous and natural desire. But both your heart and your head need to be involved in decisions to financially support an adult child. Providing specific boundaries and expectations around these arrangements will ensure both the parents and the adult children understand the benefits and limitations while maintaining family harmony. It is in both parties’ best interest for the “Bank of Mom or Dad” to stay solvent for years to come!  

The CDFA® mark is the property of The American College, which reserve sole rights to its use, and is used by permission. 
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment adviser with the SEC. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. Past performance may not be indicative of future results. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate, but is not guaranteed or warranted by Mercer Advisors.

About the Author

Kara Duckworth, CFP®, CDFA®

Managing Director of Client Experience, Mercer Advisors

Kara Duckworth is the Managing Director of Client Experience at Mercer Advisors and also leads the company’s InvestHERs program, focused on providing financial planning to serve the specific needs of women. She is a CERTIFIED FINANCIAL PLANNER and Certified Divorce Financial Analyst®. She is a frequent public speaker on financial planning topics and has been quoted in numerous industry publications.

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