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.

Should my inheritance be reduced by what my daughter owed my parents?

The complexities involved in distributing an estate continue to challenge both executors and beneficiaries. Even a simple statement such as "divide my estate equally among my children" can end up being complicated by the very real circumstances of our lives.

Recently I blogged about the fact that beneficiaries are often dismayed to find out that the "help" they received from their parents over the years in fact decreases the amount they will inherit. The following note was received from a reader who is in that situation, but with an added wrinkle. Here is the question:

"My father recently passed away. His will states that his estate is divided between 5 children and his common in law wife. I have been told that I will not recieve my full inheritance because I had a loan back in 1995 which my Mom cosigned on and when I moved away she made the payments. She passed away in 1998 so my Dad had to pay off the loan and also that my daughter owed Mom some money so that comes out of my share. The grandchildren are not even in my Dad's will and I don't see why I have to pay for her."

Unfortunately, the money you received by way of that 1995 loan is considered by law to be an advance on your inheritance. This is the case unless the will specifically tells your executor to forgive the loan, or unless you've paid it  back. The executor doesn't have any choice, as he is bound by law to reduce your inheritance by the amount you have already received.

Now the loan to the grand-daughter is another matter. I'm not at all convinced that the loan has anything to do with you. For one thing, the money was owed to your mother and this is your father's estate. For another thing, you are not your daughter. The presumption of advancement which applies to children receiving a gift does not apply to grandchildren. To me, it sounds like a real stretch to try to apply that loan to you.

However, I haven't seen the will and I don't know anything about the terms of the loan to your daughter, so I suppose there could be facts that support this position. For example, the money could actually have been given to you, and you gave it to your daughter.

Unfortunately, families almost never document this kind of arrangement because they don't want to insult anyone. This often results in keeping the feelings intact at the time, but causing much greater hurt down the line.

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.

How do I document an advance on an inheritance?

Giving someone an advance on an inheritance, and documenting it properly, can be done pretty simply. But there are a few things to watch out for. The following question from a reader raises the topic:

What is the legal procedure for a testator to give an advance to a beneficiary for a portion of their inheritance? In this case, the niece of the testator is named as a specific beneficiary in the will, but is very short on money and the testator has offered to advance them some of the money that they will inherit when the time comes. I am the executor named in this will and want to make sure that this advance is properly documented so that it won't complicate my life down the road. Would a signed statement from the testator indicating the date/sum of money/fact that it is an advance on the amount specified in the will be sufficient? Or is anything more required?

It's great that everyone in this situation appears to be working together. That's more rare than you know. I completely agree that the advance should be properly documented. This should, as you say, prevent your life as executor from being harder than it has to be. After the testator passes away, it will also give clarity to other beneficiaries of the will about what is going to happen. It will give reassurance that the testator's wishes are being properly carried out.

There isn't any particular form or notice required to be prepared. The signed statement you  mentioned would be sufficient. Make sure that the note is clear that it's an advance, not a loan or a gift. It doesn't need witnesses. It would be a good idea to keep the statement with the will.

An issue to keep in mind is that of mental capacity of the testator. You haven't mentioned it or the age of the testator. The testator should understand the nature of the transaction, and understand how it impacts his or her current financial condition. In other words, the testator shouldn't be giving away money he or she can't afford to give. If there is any question of capacity, the person to assist the testator is not the executor but the person appointed under the Enduring Power of Attorney.

One final note. Make sure that the will does not say that advances are not to be taken into consideration when the estate is divided. This would directly contradict the statement signed by the testator and could end up requiring you to ask the courts for direction.

What's in it for the heirs?

I really enjoyed this column by the Financial Post's Jonathan Chevreau, because I recognized several of my present and past clients in it. He's absolutely right that some people take steps intended to create and preserve an estate for the kids, others try to burn up every dollar, while most fall somewhere in the middle. Best of all, he gives some tips on how to achieve either maximizing or minimizing your kid's inheritance. Click here to read it. Attached photo is by Tyler Anderson, National Post.

Can an executor distribute estate assets before getting the tax clearance certificate?

PLEASE NOTE: (Update April, 2017) The maximum number of comments this system will allow is 200, and this post now has more than 200 comments. If you post on this thread now, I won't be able to read or respond to your question. Please feel free to ask your question on any other thread with less than 200 posts.

As I mentioned in a recent post about tax clearance certificates (click here to read it), an executor usually waits for Canada Revenue Agency to send him or her a Tax Clearance Certificate before giving the beneficiaries their shares of the estate. This procedure arises from the fact that an executor is required by law to pay all debts and taxes before giving money to beneficiaries, and the Clearance Certificate is proof that there are no more taxes owing by the estate.

However, there is a process for an executor to give the beneficiaries most of their inheritance before getting the Clearance Certificate, a process known as an interim distribution.

Before an executor takes this step, consider the fact that if he or she pays the beneficiaries before paying Canada Revenue Agency, that executor will have to come up with the tax money, even if it is out of his or her own money. Once you've given the money out to the beneficiaries, it's pretty hard to get some of it back again to pay taxes.

To boil down a detailed process into a simple description, the idea of an interim distribution is to hold back enough money in the estate to pay future taxes, future expenses and any legal or accounting fees, and to distribute the rest to the beneficiaries. The executor will produce a legal accounting of the estate that details all of his or her financial transactions on behalf of the estate. It will also include a Statement of Proposed Distribution that shows how much of the estate the executor proposes to give out to the beneficiaries now, and how much is being held back for taxes and other expenses. The financial documents are given to the beneficiaries along with a Release document. If all beneficiaries agree and sign their Releases, then the executor can go ahead with the interim distribution.

How do you know how much to hold back for taxes? Obviously you must get this number correct. I have never proceeded with an interim distribution without working with a tax accountant who can estimate better than I can what taxes might be owing by the estate.

Most of the time, beneficiaries will pressure executors to make an interim distribution because it takes months to get a Tax Clearance Certificate. However, beneficiaries should understand that they cannot force an executor to make an interim distribution because it means the executor is assuming risk for the payment of estate taxes.

PLEASE NOTE: The maximum number of comments this system will allow is 200, and this post now has 200 comments. If you post here now, I won't be able to read or respond to your question. Please feel free to ask your question on any thread with less than 200 posts. 

Why won't the executor give me an advance on my inheritance?

When I've acted on behalf of estates, I've occasionally been asked by beneficiaries for an advance on their shares of the estate. It's the executor's decision, not the lawyer's, but generally the executor will talk it over with the lawyer to find out his or her obligations to the beneficiaries.

When a beneficiary is refused an advance for any reason, the response is usually along the lines of "but that's MY money - I'm entitled to it!" A beneficiary is, of course, entitled to receive the share of the estate left to him or her in the Will, but not necessarily on demand. There are plenty of other things going on in an estate at any given time.

On one estate, the executor was asked to advance money to a beneficiary a day or two after the deceased's house was listed for sale. The beneficiary called numerous times, insisting that we give her her share of the proceeds. But the house hadn't sold yet. There were no proceeds to give her. This is very common. The beneficiaries don't always realize that the estate doesn't have any money until assets are sold or cashed in, and transferred to the executor's estate account.

The other thing to take into account is that on every estate, the debts must always be paid in full before the beneficiaries get their shares. It takes time to contact everyone (banks, insurers, suppliers) to find out what was owing, calculate interest, collect in or sell an asset, and pay the bill. Sometimes determining a debt means a long wait, particularly if it's for something like income tax where the amount is not always immediately known.

The executor is under no obligation to give any money to beneficiaries until debts have been ascertained and paid, and assets have been cashed in. That might take a year. It might take much longer if the estate is complicated, such as having a business to wind down or sell, or real estate in another country to sell.

If an executor is willing to advance funds before the estate is fully wound up, there is a procedure for that. The executor can hold back enough money for taxes and expenses and advance the rest to beneficiaries. Even if only one beneficiary is asking for an advance, the executor would likely give every beneficiary the same amount to keep the books simple and the beneficiaries happy. Beneficiaries should be prepared to sign a Release (not the same as a receipt) giving approval of the executor's work to the date of the advance.