Formalize your loans to your children

I'm attaching a link to an article from Jim Yih, a financial advisor and author of the www.retirehappy.ca  blog, that talks about why parents might want to formalize loans, financial gifts or advances on their children's inheritance. There are some good ideas here, so check it out by clicking here.

I was glad to see that Mr. Yih discussed parents giving instructions in their wills for dealing with these financial transactions. What the majority of parents fail to realize is that if they don't leave instructions for their executor, the law automatically characterizes loans and gifts as being advances on the child's inheritance. This means that without supporting paperwork, the executor will have no choice but to reduce the child's inheritance by the amount of the loans or gifts. Believe me, that causes no end of heartache when the child in question believed that it was a gift from his/her parents with no strings attached.

The best idea is to consider doing as Mr. Yih suggests and formalizing financial transactions between you and your children.

When my inheritance is reduced by the amount my parents gave me, where does the money go?

In this blog, you've seen a few posts from me talking about the fact that if you have had loans from your parents, your inheritance will likely be reduced by the amount you've received. This is the law, and an executor must carry it out unless the will specifically directs him to do otherwise. A reader has recently asked me about the next logical step in the process, and I'm sharing his question and my answer here.

"My dad passed away just before Christimas and left his estate to me, my brother and my sister. His will states that any money owed by us is to be taken off our share of the estate. My question is….where does this money go? Does it get put back into the estate and then split 3 ways?"

You have pretty much summarized exactly what happens.

When parents lend or give money to their adult children, it is considered by law to be an advance on the children's inheritance. For this reason, the loans or gifts have to be taken off the children's inheritance, which is often referred to as being "set off" against the inheritance. As I mentioned above, a parent who doesn't want the loans or gifts to be set off can specifically say so in his or her will. Parents should understand  that the executor doesn't have the legal authority to forgive the loans unless the will says so.

As always, the beneficiaries don't inherit their shares until all taxes, debts and liabilities of the estate have been paid. Once that has been done, the executor will calculate each beneficiary's share of what is left.

When the executor sends you his accounting of the estate, it should include a statement showing what he proposes to give each beneficiary. You should be able to see from this accounting how your loan affects the amount you and others will receive. Occasionally the math gets a bit complicated when there are loans to several beneficiaries to take into consideration, but this is an important part of the executor's accounting.

What do you mean the gift I got from my parents was my inheritance?

Have you given or loaned money to your adult children? Or, if you're the adult child, have you received financial help from your parents? If so, have you thought about how this might affect the child inheriting from the parent?

Most adult children are shocked to find out that the down payment for a home given to them by their parents 20 years ago is going to reduce or eliminate what they receive from the parents' estate. Because everyone involved referred to the transaction as a "gift", it's optimistically assumed that we can all just ignore that it happened. However, that's not the case. I received a question from a reader that addresses this issue, and I'd like to share it with you here.

Here's the question:

"Both my parents have now passed and my sister is the executor of the estate. She is now saying that the gift money my parents gave my husband and myself when my husband lost his job is my inheritance and that now I do not get my portion of the estate which is set out in the will. She says that any gifts by law are held against one's inheritance and that this is what her lawyer told her and she only wants to do what is right by the law. Is this correct? When Mom and Dad were helping us it was with a monthly amount and there was never any written contract between us or anything specified in the will but my sister knew it was a gift and I think now her resentment is coming out. But if this is correct by the law then that's fine with me."

As a general rule, it is true that gifts like the one you describe from a parent to a child during the parent's lifetime are considered to be advances on the child's inheritance. Your sister is right.

You've already said that there was no written contract or other documentation of the gift, and in fact it would be relatively unusual for a transaction like this between a parent and a child to be properly documented. Nobody ever suggests documenting it because it seems like a suggestion that one doesn't trust the other. Even if there had been full documentation of the amount and its purpose, it would still be considered an advance on your inheritance.


There are a couple of things that might change the general rule I just mentioned so that you might still share in the estate.The first thing that would change the situation would be proof that you had repaid the amount you were given. This appears not to apply to you.

The second thing would be a mention in the will that loans or gifts to children are to be "forgiven". Sometimes this type of clause in a will is called a "hotchpot" clause because it directs the executor on what is to be brought into the general estate or hotchpot for distribution. Ideally, whenever a parent has given money to one or more of the kids, there is a clear statement in the will about whether the money is to be repaid or not. In this context, "repaid" means being taken out of your inheritance, as it is in your case. However, you've said that there was nothing in the will that addresses this. Most wills don't address it, though they should.

In the absence of these exeptions, the general rule will stand and the amount you received from your parents will be considered an early inheritance. It seems that your sister has consulted a knowledgeable lawyer who has explained the rule properly to her.

I recommend that any parent who has loaned or given money to their adult kids address the situation in their will.

When is a gift not a gift? When it's a loan instead.

This article from Megan Connolly of Toronto Estates and Trusts Monitor talks about whether money advanced to an individual is a gift or a loan. Click here to read the article. Parents making loans or gifts to their adult children should take Megan's advice on this topic. There needs to be some documentation, no matter how simple, to state whether the person giving the money intends it to be a loan or a gift. Remember that after you pass away, you won't be around to clarify matters, and that might mean that your children end up in front of a judge for a ruling.

How to accept money from your relatives

This article in the Wall Street Journal talks about the family politics, legalities and other considerations that come into play when you accept a loan or a gift from family members. I think the author hit the nail right on the head.

One thing that I would add from an estate planning perspective is that if you are accepting money from your parents, ask them to include a statement in their Will about whether or not they expect it to be paid back. And if you're the parent lending money to a child, include this in your own will.

Including a statement doesn't mean that you must forgive the loan, in fact it can be the opposite if that is your wish. The purpose of including it is to avoid that huge debate that erupts when a parent passes away and the kids find out that one has had money from the parent. A brief sentence in the will (that doesn't even have to name the amount of money) is enough to head off the dispute.

Click here to read the article.

Top ten posts about parents and children

The following are the top ten posts on my blog about parents and children. Loans, wills, treating them equally, protecting them - it's all here. These tend to be the topics that take the longest time to figure out when doing estate planning. Click on the titles below to go to the articles.

1. Do I have to leave anything to an illegitimate child I haven't seen in years?

2. Using trusts to protect your children.

3. Should my parents be my executors?

4. Is "fair" the same as "equal"?

5. Putting one child in charge of a trust for another child.

6. Can I leave my child out of my Will?

7. At what age should children inherit money?

8. If my parents lend me money do I have to repay it after they pass away?

9. What do the in-laws get?

10. Can I have my parents' house as part of my share of the estate?

Is treating my children equally in my will the fair thing to do?

Most parents tell me that they want to treat their children equally in their Wills. This is not the law; you are allowed to give your adult children anything (or nothing) in your Will. If your child is handicapped or is a minor, that's a different story. Parents are pretty strict about making an equal distribution because they are well aware that doing anything else may give someone the impression of favouritism. Equal financial treatment apparently reflects equal love of the children.

For many of us, treating the children equally is as simple as stating in your Will that you want your estate divided among them in equal shares. After debts are paid and assets are sold, each child gets a cheque in the same amount.

Sometimes, though, it's not that easy. What happens when one of the children is going to inherit your business or farm? For many business owners and farm owners, that is the major asset. They don't have enough other assets to be able to give each other child the same dollar amount as the value of the business or farm.

I think business owners and farm owners should think twice before assuming that they should treat all of their children equally. To me, doing that ignores the fact that one of the children has been working in the business or farm and helping that asset achieve its current value, while the other children have not. Shouldn't that child be entitled to a larger share of the asset? Also, the child who inherits a business or farm is not being given anything for free; he or she is being given a means to make a living. The other children, who will receive cash or real estate don't have to do anything at all to get the full benefit of their inheritance, while the child inheriting the farm or business is going to have to work hard to get the value.

Having said all that, I am well aware that parents are still going to want to leave an apparently equal dollar amount to each child.

When calculating what you have in your estate to give to your other children, you should be aware that taxes arising in your estate are paid out of the residue of your estate. The residue is the part you are leaving to the child who isn't inheriting a business or farm. For example, if there is a capital gains tax liability arising on the transfer of the shares of the business from you to one of your children, the tax is not paid by the child receiving the business. It is paid from the money that the other children will inherit. Make sure you talk to an accountant or estate planning lawyer about tax implications when you are trying to equalize your estate among your children.

Even when there is no issue of a business or farm changing hands, it can be difficult to treat all children the same. Sometimes it's because there is a house or cottage that the parents particularly want one of the children to have. That house or cottage might be worth more than the child would receive if the real estate was sold and the money split.

Life insurance is one way of creating more wealth in your estate so that there is more available to give to your other children. It can be really useful to name your estate as your beneficiary so that insurance money pays into your estate on your death. Then it can be used either to pay taxes and expenses, or to top up shares to your children.

If you decide that you are going to leave an unequal amount to your children in your Will and you are afraid that this might cause hurt feelings or disputes, consider putting a brief clause in the Will to explain your reasons. For example, you might say that though you love your children equally, one is receiving a smaller share because you gave that child a lot of financial help during your lifetime and you want to treat everyone the same.

Executors collecting debts of the deceased

One of the many jobs that executors must do on the estate of someone who is deceased, is figure out what debts are owed to the deceaased, and then collect them. I would rank this among the least enjoyable of executor's tasks (not that most of them are a barrel of monkeys, mind you).

Debts owed to the deceased can range from large (e.g. an insurance settlement from a car accident) to very small (e.g. a refund from the local newspaper once the subscription is cancelled).

The general rule is that the executor must collect all legally enforceable debts. Most debts owed to a person continue to be owed after that person passes away. This is why the executor, who represents the deceased, is the one who has to collect them.

There are a couple of ways in which the Will itself can help the executor:

One of the most common debts on an estate is a loan to one of the children that the deceased parent made during his or her lifetime. Ideally, the deceased parent has given the executor some direction in the Will about whether to collect the debt. If nothing has been said, then the executor is obligated to collect that loan. The executor doesn't have the legal authority to forgive that loan if the Will doesn't allow for that. This is a really difficult thing for the executor to deal with, especially if the executor and the beneficiary who owes the money are siblings.

A way of dealing with that debt, rather than actually collecting money from the beneficiary, is to reduce the amount of money the beneficiary is going to inherit.

If you are a parent who has lent money to a child, or a child whose parent has lent money, make sure the repayment (or not) of the loan is mentioned in the parent's Will. This may certainly help to cut down on disputes.

Another place where the Will itself can be very helpful to the executor is the section of the Will that contains powers or authorities for the executor. In some Wills, there is a power to settle this kind of matter as the executor sees fit.

This clause could be helpful where the amount of the debt owed to the deceased is so small that it will actually cost more time and money to collect it than it is worth. The existence of a small debt puts the executor between a rock and a hard place, because he or she is obligated to collect all debts owing, including the small ones. However, if the power referred to is included in the Will, this will allow the executor to decide that a given debt is just not worth it to collect.

All debts that are owed to the deceased, once collected, should be put into the executor's estate bank account that every executor opens up once he or she starts working on the estate. This keeps the estate's money separate from the executor's money and keeps the records straight.

If my parents lend me money, do I have to repay it after they die?

Plenty of parents help out their children by lending money. Often it is for the down payment on a home, renovations or other major purchases. The amounts can be quite large. Sometimes the arrangement is formalized in a document, but most of the time it is not written down.

When the parent who has made a loan passes away, there is a question about whether or not the parent intended for the loan to be repaid. Often the child understands (or hopes, perhaps) that the money was a gift and the parent intended to forgive the loan all along.

But what happens if the parent makes a Will in which he or states that all of the children are to inherit equal shares? Does this mean that one child has received more than his or her share? And what if the parent died without making a Will at all? How should the loan be dealt with?

Let's look first at what happens if there is a Will. A parent can state in the Will whether or not he or she wants the loan to be forgiven. If the parent says in the Will that the children are to get equal shares of the estate but loans are to be forgiven, then the equal shares are calculated as if that loan had never been made.

If the parent says in the Will that the loan is not to be forgiven, then the child who received the money will receive less from the estate. It is rare that it actually involves the child repaying the loan. Unless the loan was larger than the share the child will inherit under the estate, it's simply a matter of subtracting the loan amount from the share. For example, if Sam was supposed to inherit $50,000 but had received a loan of $10,000 from his mother, and the mother's Will said the loan is not to be forgiven, then Sam will inherit only $40,000. This process is called set-off.

If a parent leaves a Will but doesn't say anything about loans to children, the executor must follow the general duty of collecting all debts owed to the deceased and his or her estate. This includes loans to children, so the child would have to repay it (or there would be set-off). This can be a real mess at times, for a couple of reasons. One is that if there is no documentation, the executor will have to prove the allegation that there was in fact money changing hands. This causes delays and usually friction between people as well. Another is determining the amount first loaned, and any amount repaid. The executor can't always count on co-operation from the child, for obvious reasons.

Now let's look at what happens if there is no Will and the parent has made a loan to a child. The Intestate Succession Act specifically states that in this case, any money given to a child is deemed by law to be a loan and not a gift. This would mean repayment or set-off. The same problems exist for establishing the amounts.

If you are a parent who has made a loan to one or more of your children, check your Will to see whether you've addressed the issue of repayment of loans. If not, do your children and your executor a big favour and deal with it so that nobody has to guess or litigate to figure out what you intended.

Do my kids have to repay my loans to them?

Plenty of parents have loaned money to their adult children, to help them buy homes, buy cars or for many other reasons. Usually a parent has loaned more to one child than the others because that child had a particular reason for needing help.

When the parent dies, what happens about the loans? Do the children have to pay them back or not?

The answer depends on the parent's Will. In the best case scenario, the parent has said something about the loans to give the executor direction as to what should be done. The parent can either say the loans are to be repaid, or say that they are to be forgiven. The executor will then know how to deal with it.

The parent does not usually mention a dollar amount in the Will, because he or she expects that the child will repay some or all of the loan during the parent's lifetime. In such case either the parent or the child will have to keep receipts or records of some kind to document any amounts that were repaid.

What happens most of the time, unfortunately, is that the parent doesn't say anything about the loans in the Will. If that is the case, the executor has to fall back on the law to know what to do. The executor's job includes gathering in any money that is owed to the deceased parent, and that includes loans to adult children. This is an area that causes one heck of a lot of trouble when a parent dies, because the adult child who has had a loan might say that he and the parent had an understanding that the loan should not be repaid. In other words, it wasn't a loan, it was a gift and the parent at no time intended it to interfere with any inheritance. Without the parent's written instructions to back that up, the executor is going to have to collect the debt. The executor isn't legally in a position to say "oh just forget about it."

In practice, what happens is that if the adult child is going to inherit anything from the parent's estate, he or she doesn't actually repay the money to the estate. Instead, the amount that he or she owes is subtracted from the inheritance (called a set-off).

Whenever I talk to people to plan their Wills, I always ask whether they have loaned any money to their adult children, and ask them what they want done about it. Many parents are committed to the idea that all children are to be treated equally and therefore any loans must be set off. Other parents believe that they gave help that was really needed and that it would punish the child to have to repay the money. Everyone has his or her own view on this.

If you have adult children to whom you've made loans, make sure this is addressed in your Will. If you are one of those adult children who has had a loan from parents, perhaps you should suggest to your parents that they mention in the Will what is to happen about the loan after the parent has passed away.