Many of our clients are considering providing assistance to their children who are beginning their careers and shopping for their first homes. This shouldn’t come as a surprise since recent college graduates are saddled with historically high levels of student loan debt. And if the job market softens, these young professionals will receive a “double whammy.” Naturally, most parents want to do anything possible to help their kids get a good start in life and purchasing a home typically is high on their list of what constitutes “a good start.”
But as fiduciary financial advisors, we must counsel our clients in their best interest — something they may personally overlook in their attempt to support their children. This goes back to the principle I have consistently stressed to my clients over the years: We don’t do our kids any favors by compromising our ability to remain financially independent so we don’t become a financial burden in our later years.
In other words, one of the best things we can do for our kids most of the time is to make sure we aren’t sacrificing our own financial well-being for their priorities.
Helping without hurting
For some clients, it can make sense to offer the kids a boost toward financial independence, including some type of help for purchasing that first home.
For example, a friend of mine, an experienced realtor, owns a number of residential properties as part of her investment portfolio. When her father-in-law passed away several years ago, she and her husband inherited a significant amount of cash from the sale of the deceased’s paid-off property. My friend wanted to re-invest this cash in a similar asset. Coincidently at that time, her son and his wife, who had just added a new child to the family, were looking to buy a home with a little more space than their rental property.
In this case, re-investing the sale proceeds from her late father-in-law’s home in a home for her son (and grandchildren) allowed my friend to maintain the desired balance of her portfolio allocated to real estate. By structuring the payments from her son as a regular mortgage, she’s helping him build equity and generating monthly income for herself.
Gifting without triggering taxes
Of course, some HNW clients may prefer to just gift their children some or all of the down payment amount or even the entire purchase price of the property. Gifting can help reduce the size of the taxable estate by transferring assets to the next generation. In the case of a home, these assets can then appreciate in value.
In 2023, a married couple can gift up to $34,000 to an individual without triggering gift tax. So, if a couple with means wants to gift to both their child and the child’s spouse, they could give away up to $68,000. Most lenders (along with the IRS) require a “gift letter” specifying that the donor does not expect repayment from the recipient and documenting the presence and availability of the donated funds.
In other words, it must be an outright gift, not a loan disguised as a gift. In fact, a “stealth loan” would add to the child’s documented indebtedness, potentially adversely affecting their credit rating and possibly their future ability to secure financing for another purpose.
What are the downsides?
Clients who can afford to gift their children some or all of the purchase price of a new home should avoid putting the new homeowners in more house than they can afford. Even if the mortgage payment is manageable (or non-existent), the young family will still have to keep up with property taxes, insurance, upkeep expenses and possibly homeowners-association (HOA) fees.
I believe the children should be prepared to assume these ongoing costs of ownership. Parents should not put themselves in the position of serving as “property managers” for their children’s homes. Remember, the idea is to set them on a path to self-reliance, not continual and habitual dependence on Mom and Dad. We can and should counsel our clients most carefully about this.
Don’t skip the tough conversations
If a client is raiding retirement funds, taking on debt (either on their own or by co-signing with their children) or otherwise impairing the financial viability of their retirement lifestyle, we should advise against this in the strongest possible terms. I realize that this can quickly move from a financial discussion to an emotional one, but in my experience, it is vital to put all the cards on the table.
I’ve had client couples significantly divided on this issue, with one partner ready to do “anything and everything” to help the child, and the other insistent upon insulating the child’s financial priorities from the parents’ needs. This is where a fiduciary advisor can step in and offer some clear, objective financial counsel.
You may need to ask your client some hard questions:
- “If you co-sign and your child falls behind on payments, you’ll be responsible for the payments and the hit to your credit rating; Are you okay with that?”
- “Based on what you’ve told me about your child’s employment and work history, are you sure they’ll be able to handle this mortgage, if you help them get it?”
- “Can your current cash flow handle all your current obligations and your child’s house payment, too?”
- “What aspect of your current lifestyle are you willing to give up if this loan to your child doesn’t work out?”
While it’s not enjoyable to contemplate scenarios like these, many of us have seen them play out in our clients’ lives and those of their children. Our fiduciary obligation requires us to make sure that clients enter these situations with their eyes open.
For those who can afford it, helping the kids get into their first home can be a wonderful and meaningful experience. But we need to help them make sure they’ve covered all the bases. We can’t afford to let our clients’ wish to confer “the American dream” on their children turn into a financial nightmare.
Kimberly Foss is a CERTIFIED FINANCIAL PLANNER™ professional at Mercer Advisors practicing in the Sacramento Valley area. The opinions expressed by the author are her own and are not intended to serve as specific financial, accounting or tax advice. They reflect the judgment of the author as of the date of publication and are subject to change. Some of the content provided comes from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Mercer Global Advisors Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services.