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Parent to child loan agreements and wealth protection

Commonly asked questions about parent to child loans:

It is important to bear in mind the possibility of your child’s relationship breakdown or bankruptcy. In the context of a relationship breakdown, a failure to document a parent to child loan correctly can have severe consequences for both you and your child. For example, a gift made by you to your child could be viewed as an asset of your child’s relationship, and divided between your child and their spouse or partner.

Federal and state courts can view a parent to child loan as a resource of the child to be taken into account when the court divides the other assets. The particular terms of the loan agreement will affect the likelihood of the court viewing the loan as an asset of the relationship or a financial resource of the child.

If your child receives a loan from you and then becomes bankrupt, then failing to take security over your child’s assets may mean that other creditors get paid before you do.

You should also think about how the loan to your child fits into your overall estate plan. Although loan agreements will usually state that the loan is repayable on death, the following should nevertheless be considered:

  • Will you forgive the debt in your will and compensate your other children accordingly?
  • What will you do if your child passes away before you do, potentially leaving a spouse/partner and/or children who are unable to repay the loan? Having security over your child’s assets would give you the flexibility to recall the loan immediately or at a later date.
  • Similarly, if the loan was invested in your child’s superannuation fund, you may find it hard to obtain repayment unless you have security over your child’s assets, such as real estate.

Where there is a risk of the child going bankrupt or suffering a relationship breakdown, or where you require flexibility in the case of either you or your child passing away, the following options should be considered:

  • Loans should be acknowledged by both your child and their spouse/partner and at least annually the child should make repayments of the principal or pay interest.
  • You should consider taking security over the loan, such as a mortgage over real estate.
  • You should review your estate planning documents to ensure that they put into effect your intentions in relation to the loan.
  • Your executors and attorneys should be alerted to the existence of the loan and your intentions concerning whether the loan is to be forgiven or repaid.
  • You should seek specific taxation advice before entering into a loan agreement.

If there is a dispute in the future, it will generally be the parent who has to prove that the loan was not a gift. An appropriately drafted loan agreement can help resolve disputes and help to prevent them from occurring. Your Stacks lawyer will be able to assist you with creating a loan agreement that protects both parties financially.

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