It is not unusual to encounter the issue of loans made by parents to children. These are often not documented in writing. The parent and the child are often the only ones who know of the loan. It is common for the loan to be open-ended without interest. The child is simply supposed to pay the loan back when they can.
These are not documented for a number of reasons. Parents often feel that it is too formal for them to draw up a loan agreement with the child. They trust the child and expect him or her to honor their agreement to pay back the debt.
This can present something of a problem in the estate planning area. When a parent leaves his or her estate to the children equally, does that mean that the loan or debt should be treated as a part of the child’s share? Or should it be forgiven?
If the loan is undocumented, there is no means to enforce repayment of the loan to the estate or to treat it as a part of the child’s share unless he or she voluntarily agrees. Often, the child is not in the position to pay back the loan. It may actually exceed his or her equal share of the estate.
The siblings may be aware of the loan, but are not aware of its status. Has it been paid back? Partially? None of it? This affects the amount of their pro-rata share of the estate.
It may be that the loan recipient has received a number of loans from the parents. Siblings can be resentful and ready to enforce repayment of the loans. Unfortunately, without anything in writing, there is no avenue for recovery. Even when the check written to the child can be found, it is not proof of a loan without a writing that documents it is a loan. It could be a check written as a gift and will in all likelihood be categorized as such.
This is the type of issue that pits siblings against one another after the passing of their parents. The loan recipient may feel that the siblings are being greedy. The siblings feel they are being short-changed.
As a parent, do you need to have a complicated legal agreement drawn up to document a loan to one of your children? No. The loan agreement can be simply done, stating the date of the loan, the amount, the terms, if any, the fact that it must be repaid. Both parties should sign it. Done.
Parents should address the issue of loans in their Will or Trust. Either loans made to family members should be forgiven if not paid, or the loans should be treated as a part of the child’s share.
While the most common situation involves parents making loans to children, it can be the other way around. Parents on a fixed income may deplete their savings and need assistance. If that assistance is not being equally shared by all the children and is coming from one individual, it should be documented. In that way, upon the parents’ deaths, the child who made the loans can receive at least a partial repayment if there are any assets left. Again this loan arrangement should be in writing.
Once again, it is appropriate for the parents to address this issue in their estate planning documents, specifically stating that loans received from the child or children are to be repaid prior to dividing the estate among all of the children.
Keep it simple – but put it in writing.