Just as flight attendants instruct adult passengers to put their own oxygen masks in place before assisting children, financial planners advise clients to pause before rushing into an act of parental generosity.
"The basis of financial planning, in my philosophy, is to assure that the client doesn't run out of money before they run out of breath," says Barry Kohler, a Certified Financial Planner in Portland, Maine.
Once you're confident that you'll have more than enough resources to last a lifetime, you can look at the surplus to determine how much you can afford to spend on your adult offspring.
Consider these four issues before you decide to lend your adult child a financial helping hand.
The dent to your retirement income
Joel Larsen, a Certified Financial Planner in Davis, Calif., works with clients to create financial models projecting how certain choices — such as helping a child purchase a home — might affect their future retirement income.
"What we would do is say, 'Beginning on this date, you'll no longer have that money in your portfolio,'" Larsen says. If the financial assist will set the client back further from his retirement goals than he feels comfortable with, his advice is to think twice.
It all boils down to risk management: How much can you afford to do without?
"If the client's got $60,000 in the bank and a half-million dollars' worth of investments and a public pension and they want to give the kid five hundred bucks, we don't need to do that math," Larsen says. "That's between them and the kid. But you know at what point it makes a difference. Your gut will tell you."
The risk to your credit rating
Before you set up a joint checking or credit card account with your adult child, remember that whatever he or she does with the account becomes part of your credit record. For that reason, Larsen is emphatically against the whole idea. "Do not drag your credit down," he says. "Do not give a blank check."
Kohler warns that you should also tread carefully when it comes to co-signing a loan. "When anybody co-signs an obligation for some other person, the co-signer needs to say, 'If I have to pay this whole thing, what shape will I be in?'" he says.
Paula Nangle, a Certified Financial Planner in Doylestown, Pa., says one of her clients learned this painful lesson when he recently tried to refinance his home.
"Five years ago, he co-signed a car loan for his son's girlfriend and she subsequently defaulted on the loan," Nangle says. "It showed up on his credit report and he had to pay off the remaining balance on the loan before he could close on his refinance."
The potential tax implications
Unless you are making a loan that's documented and structured to meet the legal requirements, the Internal Revenue Service may consider your family aid to be a taxable gift. When the gift tax applies, it's the giver who owes Uncle Sam.
Gifts that are less than the annual exclusion amount are not subject to the tax. For 2011, the limit is $13,000 per recipient for individuals and $26,000 for married couples who agree to combine their exclusions (a process called "gift splitting") and document that choice by filing a gift tax return.
Tuition and medical expenses paid directly to an educational or medical institution on someone else's behalf are also exempt from taxation.
If you exceed the limit for a gift to any one person during the tax year, you must file a gift tax return, IRS Form 709. You won't owe the tax until you reach the lifetime exemption limit, which is currently $5 million for individuals and $10 million for married couples.
The IRS defines a gift as "any transfer (of property) to an individual, either directly or indirectly, where full consideration is not received in return." So be careful about handing over a house or car for some token amount. The difference between the real value and the payment you receive may be subject to the gift tax.
The impact on family relationships
"Parents need to take a step back and objectively examine the possible implications of the decision to help," Nangle says. "Will it really help your child or is it just enabling them to take the easy way out?"
Another issue to consider, Larsen says, is whether you have other children who will feel slighted or shortchanged because their inheritance will be reduced by the money you spend on their sibling.
Of course, no one would fault a parent for making exceptions to the general hands-off rule in the case of an emergency or a short-term crisis.
"If your adult child is in a financial bind because they were laid off unexpectedly, I don't think it's a problem," Kohler says. "On the other hand, if after two years the kid is just watching MTV and not looking for work, a responsible parent would address the problem."
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