If you have adult children, you may want to help them out financially — say, help them pay off their student debt, buy a home or start a business.
Although gifting assets may sound simple in theory, in practice it can present pitfalls. The same goes for making substantial loans to your children. This article will help you understand the consequences of a gift or loan to an adult child, as well as the strategies that can help ensure potential problems are avoided or minimized.
Are you planning to gift assets?
If you’re planning to gift assets — whether property or money — to an adult child, there are several potential issues to consider.
Loss of control: Once the asset is gifted, the recipient has control and is free to do whatever they’d like with it. If you are giving money to your child for what you feel is a worthy goal, you’ll want to communicate your wishes clearly ahead of time. You won’t be able to take back the gift, even if your child is doing something with it that you don’t like.
Exposure to the child’s creditors: If your child has unpaid debts, a gifted asset could be exposed to creditor claims. If you’re concerned about this, you might want to retain ownership until your child’s financial situation has improved. Other options might be lending them the money instead of gifting it (more on this below); or setting up a discretionary trust, which allows your child to benefit from the asset (i.e., draw income and/or capital) without owning it.
Marriage breakdown: If your child’s marriage or common-law partnership ends, a gifted asset might be subject to division of family property. One way to deal with this is to ensure that, before you make the gift to your child, they have a domestic contract in place that specifically excludes the asset in the event of a relationship breakdown. Domestic contracts include things like cohabitation agreements, prenuptial agreements and marriage contracts.
Loaning rather than gifting offers protection
One way to avoid the potential problems associated with creditors or marriage breakdown is to loan money to your child instead. Remember, a loan is a debt to be repaid, not an asset. If a loan is the route you choose, there are several key issues to keep in mind.
Carefully document the loan. Proper documentation ensures the loan terms are clear and legally enforceable. That way, if an issue arises for your child in the future (like a divorce), there will be formal documentation in place to show that the loan was not intended to be treated as a gift, making it more difficult for your child (or their creditors or spouse) to claim the loan was a sham from the start.
Make it a secured loan. If the loan is to buy property, consider registering a security interest, a lien or a mortgage. (A security interest is a right that a lender takes over their loaned property to ensure the loan recipient fulfills any obligations related to the loan.) This way, if your child is being pursued by creditors, certain creditors may have to line up behind you, allowing you to keep the assets in the family.
Harmonize your loan with your child’s other financing. Let’s say you want to loan money to your child for a down payment on a house, but they also need financing from a bank. Because your loan is added to the child’s total debt load, it could potentially prevent them from qualifying for a mortgage. In such a case, a loan to a child won’t work — only a gift will.
Be aware of any limitation periods. We know parents want to help their children, but sometimes things go sideways. What’s more, your child’s life could be complicated by an ex-spouse or creditors, or their unpaid loan could become an issue when your estate is being settled. Limitation periods define the period during which a creditor can take legal action to collect an unpaid debt. If you’re loaning assets, make sure you understand any applicable limitation periods to ensure your loan remains legally enforceable.
Finally, if you loan money to your child, you need to consider what happens if the debt is still outstanding when you die. Do you want the loan to be paid back to your estate? Or will it be forgiven? You should clearly set this out in your will.
Equalizing assets among your children
If your goal is to leave equal amounts to all of your children when you die, what about substantial gifts or loans you made during your lifetime?
If you want advanced amounts to be taken into account, you’ll need to keep records of who got what over the years, and also document your intentions in your will. In addition to fulfilling your wishes, this will also help avoid misunderstandings.
Get professional advice
Gifting or loaning assets to adult children may be a part of your financial plan. Don’t let your goals go by the wayside due to unforeseen obstacles and unintended consequences. An MD Advisor*, along with your professional legal and tax advisors, can help you steer a clear path.
*MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.