In part two of our series on the Bank of Mum and Dad, we discuss how loans from parents to adult children can have a range of consequences when it comes to estate planning and general issues faced by ageing parents.
Death of both parents
Consider a couple with two adult children, who lend a significant amount of money to one of their children but do not formally document the loan. The parents’ wills provide that upon both their deaths, their estate is to be distributed equally between the two children. The exact value of the estate will not be known until the death of the second parent. It may be that the value of the remaining loan amount owing by the child is significantly more than the value of the balance of the estate.
When undertaking their estate planning, the parents need to consider how they intend the loan will be treated upon their deaths:
- Do they expect their child to repay the loan to their estate so that the two siblings can then take an equal share of the total estate? If so, the loan needs to be formally documented otherwise the executors of their estate may treat it as a gift to the child and not available to be repaid and distributed from their estate.
- Or is the loan to be forgiven and treated as a gift? If so, there needs to be an adjustment in the other’s child favour upon the distribution of the estate.
Loss of capacity
Parents often appoint their adult children as their attorneys. This allows their children to manage their affairs (and in doing so, make financial and/or personal and health decisions on their behalf), should the parents later lose capacity.
If a parent loses capacity and can no longer live independently, their child (as their attorney) will be required to decide how to fund their entry into an aged care facility. Under the powers of attorney legislation, it is a conflict of the child’s duty as attorney to prioritise their own interests by selling the parent’s other assets ahead of repayment of the loan owing by the child to the parent, in order to fund the entry to the aged care facility.
If it is the parent’s wish that the repayment of the loan should be the very last resort for their attorney/s, this should be made clear in the terms of the Enduring Power of Attorney document.
Death and/or bankruptcy of the child
If parents lend money to their child and do not formally document the loan and secure it:
- in the event of the child’s death, it is possible that the executors of his/her estate will treat the loan as a gift to the child and therefore an asset to be distributed from their estate, instead of it being repaid to the parents.
- in the event of the child becoming bankrupt, the trustee in bankruptcy may treat the loan as a gift and refuse to repay the amount owed to the parents and instead pay it to the child’s creditors.
What should parents do if they want to loan money to their adult children?
We recommend that parents seek legal advice if they are considering lending money to their adult children. If they do decide to lend money, the terms of the loan should be clearly documented in a formal loan agreement signed by all parties, and in particular, should state:
- When the parents can call on their child to repay part or all of the loan, e.g. if one or both of the parents can no longer live independently and need to move into an aged care facility with Xmonth’s notice to the child.
- Whether the parents have the right to secure the loan against their child’s assets. Taking security over a child’s assets gives parents priority over any unsecured creditors in the event the child is declared bankrupt.
Parents should also ensure that their wills and enduring powers of attorney are up to date and take into account the loan to their children.
For more information, please contact a member of our estate planning team at Fox and Thomas.