There are a number of legal tools that can be used to put together an effective estate plan. This is especially true when you keep in mind that estate planning is about more than just transferring assets, it’s about wealth management.
One tool that can be beneficial in certain situations is the use of an intra-family loan.
What is an intra-family loan? Much like the name implies, an intra-family loan is a loan of money given to one family member from another family member. Examples include a grandparent paying the college tuition for a grandchild, a parent helping to cover the down payment costs when their child is purchasing home or a family member funding the entrepreneurial ambitions of another.
Aren’t these loans considered gifts? That depends. If the loan is given without the expectation that it is repaid or without any interest, then it would likely qualify as a gift. However, if repayment expectations are clear and an interest rate is applied the loan does not qualify as a gift.
The distinction is important. If the loan were viewed as a gift, tax implications would apply. This would defeat the purpose of using these loans as a wealth preservation tool.
Wait a minute, I have to charge my family interest? How does that preserve wealth? In order to take advantage of this legal tool, an interest rate must be used. However, this interest rate can be significantly lower than market value. In some cases, an interest rate as low as 0.56 percent will suffice. The exact amount will vary depending on the applicable federal rate.
When used wisely, this means that the recipient of the loan not only receives the funds at a lower rate than he or she would from the bank, but can also make more if these funds are invested wisely. In addition, since the interest rate is paid to the grantor of the loan, the money used to pay the interest also remains within the family.