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.

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.