Protect yourself while bailing out a relative in debt
So you've gone through our 4 steps to help a loved one in money trouble and now you want to offer financial support.
Before you start handing out money, you need to set limits, establish a plan that doesn't endanger your own financial security and ensures your money is going where it’s intended.
Put these five smart moves to good use and tread carefully.
Smart move 1. Set your limits.
Helping someone with money is like trying to rescue someone who is drowning. Don't even think about it unless you can stay afloat yourself.
Your attempt to save them should not put your own finances at risk.
You'll want to examine your household income, expenses and cash flow to determine how much money you can really spare. It shouldn't be about how much they need, it's about identifying your own limits.
It could be $200 or tens of thousands of dollars, depending on your financial situation. Whatever that number is, it should only come from your discretionary income.
Bill Hammer Jr. of Hammer Wealth Group in Melville, New York, says you shouldn't let emotion rule this decision.
Do the math. You don't want to go into debt yourself or pull money from your retirement account.
Smart move 2. Don't give cash.
If your relative or friend has financial problems, it's almost a given that they might not have the best money management skills.
Blindly handing over a check every month may just be throwing your money into a black hole. They need to be accountable, and you have the right to know where that money is going.
Larry Rosenthal, a certified financial planner with Rosenthal Wealth Management Group in Manassas, Virginia, says one option is to offer to pay their creditors or bills for them.
"It's better to pay bills directly," Rosenthal says. "Write the check not to them but to the utility company, credit card company or whoever it may be. People who are in these situations often don't put the money towards what they're supposed to."
If you can pitch in $200 per month, then offer to pay $200 worth of bills directly. If you want to help cover groceries, consider gift cards to grocery stores.
Another good way to keep tabs is to open a joint online checking account with them. You can fund it, then track their debit card purchases.
Smart move 3. Consider a low-interest loan.
Another option may be to offer the person a low-interest loan.
If your relative pays 20% on a $10,000 credit card balance, you might be able to offer a personal loan at 5%.
It could save them thousands of dollars in interest and would drastically reduce their minimum payments. It could also be a decent investment for you.
The big risk with this option is that you may not get paid in time or get paid back at all. If the person got into trouble with debt once, it could certainly happen again.
A creditor may sic a collection agency on them for not paying, but they know you're not going to do that.
You're more likely to cut them slack when bills are due. So there's a good chance, if funds are still tight, you'll be the last to be paid.
Another big risk is they could simultaneously be wracking up more debt as they're paying you off. They'll essentially be treading water and not improving their situation.
This is why it's important to maintain oversight over bills and account statements.
If you do offer a bigger loan, you may want to make it official, as there are government rules to follow for tax and reporting purposes. Seek professional advice.
Smart move 4. Don't put debts in your name.
The debt is your relative's debt. The last thing you want to do is cosign a loan or open a joint credit card because they could drag you down with them.
Their late payments and defaults could become yours, damaging your own credit score and putting you at risk financially.
A better option is to help guide them to lower-interest solutions.
Paying 5% on a home equity loan is a better option than paying 20% on credit card debt. On a $10,000 debt, they'd be saving $1,500 per year in interest.
But you'll have to maintain vigilance here. If your relative fails to repay the home equity loan, he or she risks losing their house.
If they don't own a home, don't have enough equity or good enough credit for a loan, there are other options.
You could help them seek the assistance of a debt counselor to negotiate lower interest rates or balance reductions.
Smart move 5. Bring in a professional.
You may also want to consider seeking the advice of a financial adviser, tax consultant or attorney.
There are many people who have creative solutions for money problems like this and specialize in the transfer of assets.
For example, if you give your relative more than $14,000 in a calendar year, you could trigger gift taxes. You'll want to consult an accountant so you can do it in a way to minimize the tax burden.
Document the transfers or donations you give to the person and maintain records.
In some cases, an adult child or aging parent can be claimed as a dependent on your tax return, assuming they meet the IRS criteria. It could net you some tax deductions and credits.
If the person is an aging parent, you may also want to think about estate planning, says Michael Chadwick, a certified financial planner and CEO of Chadwick Financial Advisors in Unionville, Connecticut.
If there are assets to leave behind, or you're the beneficiary of a life insurance policy, that could factor into your ability to offer financial assistance.
It's not a pleasant thing to think about, but knowing you're going to receive money when they're gone may allow you to offer more assistance while they're alive.
It sounds selfish, but you need to seriously consider your own financial well-being. You, too, will get old someday and need to plan for your future.
So don't take any money out of your retirement fund.
But if you're socking away a fair amount of money every year, maybe you divert half those savings to help your parent with the knowledge you'll be paid back through an inheritance.
Chadwick says it's a risky last resort.
He has seen cases where an adult child helps a parent with the expectation of later inheriting their house, only to find that the parent drained the house of its equity.
Or they might find that the life insurance policy the parent had was a term policy and had expired.
You can minimize these risks by glancing over documents or having the house in your name.
"I think it's a fine thing to do, but you have to build safeguards for yourself, because it doesn't always play out with all the assets in place," Chadwick says.