Family wealth can take a life-time to accrue, but disappear in an instant through some poorly considered generosity. So called “family friendly loans” are becoming the vehicle of choice among parents transferring assets to their adult children in order to protect family wealth
Uncertainty over family relationships and future financial security is seeing a move away from simply gifting assets to the next generation. When it comes to parents passing on assets, family friendly loans have emerged as a more popular alternative to straight out gifting. These loans are favoured particularly by parents who are looking to help out their children but at the same time are unsure of their own future financial requirements, and want to protect the assets from becoming part of an adult child’s divorce settlement.
This type of arrangement is becoming increasingly common in the case of farms, rental properties and interests in family businesses. The child receives the benefit of the asset but owes the parents for the asset value. A written loan agreement would be signed, secured over the relevant asset. That loan may be a no-interest loan or one with minimal interest linked to the official cash rate plus a margin.
While the adult child receives an immediate benefit, this approach can also provide for a more equitable estate distribution down the track. An example case of how this may work follows in this case study.
John is one of two children (eg. John and Mary). John receives a $1million loan during his parents’ lifetime to acquire the family farm. Mary has not received any such financial support. Upon death of the last surviving parent, that parent’s estate comprised $2million in cash and the $1million debt due by John. If John’s $1million debt were released, then (depending on the drafting of the Will) it is possible that the $2m cash would be equally split with $1m to each of John and Mary – perhaps unintended by the parents. However, appropriate planning may be to include John’s debt in the estate without releasing John. The estate comprises assets of $3m, which the Will divides equally. The Will details that John is to receive, as part of his share, the $1m debt due to the parents (and the benefit of the security for that debt). In this way, John and Mary each receive $1.5m in value, albeit John effectively receives a release of his debt plus cash of $500,000 whilst Mary receives cash of $1.5m. A more equitable result.
Upon the death of the parents, a family friendly loan enables the debt to be released or transferred to specific family beneficiaries. Alternatively, if the parents face unexpected financial costs late in life such as for health issues, or if family relationships change, they have the option of calling up the debt or charging interest. In the event of a child’s divorce, the loan could be recalled to avoid it becoming part of a settlement.
At Cowell Clarke, we undertake considerable work involving asset transfers under broader succession planning strategies. This is where parents in their living years are looking to pass on the baton to the next generation, as well as provide some form of financial assistance to their children but with a safeguard in place.
For more information on succession planning and estate matters please contact Peter Slegers.
Written by Andrew Sinclair (formerly employed by Cowell Clarke)