Q Dear Rick:
I have an estate planning question that I hope you can help me with. I am a widow with three adult children. In my will I leave everything equally to my three children. About 10 years ago I loaned my youngest son $50,000 to start a business. Nothing was in writing but he had agreed to pay me back within five years. His business went belly up and obviously, I was never repaid. My first question is when I pass away, what happens to that loan? Does it automatically get discharged or does it come out of my son’s share? I think to be fair to my other children it should come out of his share. Is there anything I need to do to make sure this happens?
A Dear Lynn:
The loan that you made to your son would typically be treated as an asset of the estate. What normally would happen upon death is that the discharge of the loan to your son would be part of his distribution. For example, if upon death the value of your estate, including that outstanding debt, was $150,000 and thus, each child would be entitled to a $50,000 distribution upon your death, then instead of getting $50,000 as an inheritance, his inheritance would be the discharge of the debt. However, the problem in your case is the fact that there is nothing in writing. If your son says that it was a gift and not a loan, it could cause all sorts of problems within the family. Fights like this can get very nasty and that is not something anyone would want upon their death. After all, as I’ve said many times in the past, the main reason people do an estate plan is not to save on taxes or avoid probate, which are admirable goals, but rather, because they want to make things as easy as possible for their loved ones. Because of this, I believe a change in your estate planning documents is needed.
What I would recommend is that you amend your estate planning documents and specifically set forth what you would want to happen to the outstanding debt upon your death. By you putting it in your will, it should eliminate any potential for disputes within the family. I believe the key for you is to make sure your wishes are clearly stated within your estate planning documents.
Family members frequently loan money to other family members and typically, nothing is put in writing. The main reason people don’t put it in writing is because they trust the other person and so they feel it is not necessary. Unfortunately, when things are not put in writing it could cause problems. As I tell people all the time, the reason you put it in writing is not because you don’t trust the other person. After all, why would you loan money to someone you did not trust? Rather, the reason why you put it in writing is so there is a meeting of the minds ensuring that from the beginning, everyone is on the same page. For example, in a loan situation it is important to have something in writing so that the parties to the agreement understand if there is interest or not, are there periodic payments on the loan or one lump sum payment. The bottom line, you put things in writing so both parties understand what they are getting involved in.
Loans within families are is a great potential to cause a problem upon death. That is why I generally recommend that if you do make loans within the family, even if you have a loan document in writing, you need to address it in your estate planning documents. In addition, it is also important that you have some process to document if and when the loan is repaid. After all, if the loan is repaid and is not properly documented, that also can cause problems.
Loaning money to family and friends is a wonderful gesture and can really make a difference in someone’s life. However, as part of the process to make sure that a good gesture doesn’t cause all sorts of other problems, it is important to document the terms of the deal.
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at email@example.com