A Sometimes Poisonous Mix: Family & Money

Giving and receiving money between family members takes some care and consideration to make sure everyone’s needs are met. There are tips that can equip you for dealing with family and money situations.

Loaning Money

Loans between family members can be win-win situations. Borrowers may get access to cash at lower rates. The relatives lending the money can feel good about helping — and they may even get a slightly better return than the current environment affords.

That said, lending between family members can get awkward — quickly — if things go awry. Think seriously before entering into this arrangement:

  • Plan to charge interest. As much as you might like to offer an interest-free loan, doing so may trigger gift and income tax consequences for you. Avoid these problems by charging at least a minimum interest rate set by the Treasury, called the applicable federal rate. (Find details and current rates at irs.gov.)
  • Create a contract. Agree on the “what ifs” before the money is loaned. Nail down the terms of the loan — interest rate, payoff period, payment frequency, and so on in writing. Also discuss the consequences if, for instance, the borrower doesn’t repay the loan or if payments are repeatedly late.
  • Don’t be afraid to say no. You can’t say yes to every request. And just because you loaned money to one relative doesn’t mean you have to help another.

Giving Gifts

You may have heard about the maximum amount you can gift to someone without incurring tax consequences. For 2013, the maximum per person is $14,000. That means that a couple giving to another individual could each give $14,000 for a total of $28,000 in one year.

If the recipient is in college and receives financial aid, for instance, a large financial gift could significantly reduce the amount of aid for which they’re eligible. That’s because students must report cash gifts from anyone other than parents on the federal financial aid form.

There’s also the risk the recipient may spend the money in a way other than what you intended. To avoid these pitfalls, consider:

A custodial account. Accounts set up under the Uniform Transfer to Minors Act (UTMA) are custodial accounts that can be used to transfer money to a child and obtain certain tax benefits. UTMAs are not tax-deferred, but they can serve as viable college planning options because the minor is the owner of the account and, in general, the minor’s tax rate determines taxes due on the assets.

A 529 plan. These college savings plans are available in all 50 states. In some states, contributions are free of state taxes (up to certain limits). Also, earnings grow free of federal taxes and stay federally tax-free for qualified withdrawals.

An IRA. For kids who have earned income, an IRA could be the proverbial gift that keeps on giving. Options include conventional IRAs, which allow for tax-deductible contributions, or Roth IRAs, which allow for tax-free growth and tax-free withdrawals at retirement. Withdrawals prior to age 59½ may be subject to a 10% IRS penalty tax.

With some thought and the assistance of your financial professional, you can learn to handle different situations with relative ease.

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

This communication is intended to provide general information about the subject matter covered and is provided with the understanding that none of the member companies of The Principal® are rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.