By Rico Dilello
It’s natural for parents to want to help and support their children. But should that help continue well into adulthood? By helping too much, parents run the risk of imperiling their own financial future and creating dependence. The reality is that you are not doing the adult kids any favors by always bailing them out.
The Great Recession rewrote some of the rules of financial independence for many young adults. With jobs being scarce, student debt soaring and high household debt, it wasn’t uncommon for grown children to take refuge in their childhood homes.
Those were unusual circumstances when even hardworking children found themselves in financial straits. It is okay to help them if they are financially responsible but have fallen on hard times. However, an “open wallet” policy is dangerous for parents as well as children. Always coming to their rescue can jeopardize both your child’s drive and your retirement security.
Tough Love: Teaching Financial Responsibility
The best defense against dependent children is increasing financial responsibility as children grow. You need to start the process when your children are young. Counting on the school system or waiting until after they graduate college can be a costly mistake.
I strongly recommend pushing your young children to get part-time jobs. If they are driving the family car, make them pay for some gas or a portion of the car insurance. Paying for some or all of their cell phone bill is another way to teach financial responsibility. Avoid always acting as their personal taxi service, make them take public transportation once in a while.
My son never wanted to use the family van when going out with his friends while living at home. Going away to university, he spent two years taking public transportation, that experience really changed his attitude. He was so grateful that I gave him our 10-year-old van instead of trading it in.
It’s okay to say no! My eight year old daughter asked for horseback riding lessons. I honestly didn’t take her request seriously. I said that riding lessons are expensive and we didn’t have the money right now. She came back with the job section of our local newspaper. She pointed to an ad that was looking for delivery people. “Is this enough money to pay for riding lessons”? It wasn’t but we said yes to riding if she was willing to give us half her earnings from the paper route. (We invested her money and gave it back when she graduated from university).
The Right Kind of Help
- If your children need a car to get to work, consider giving them an old family car that is still reliable. A few repair bills can teach them some added responsibility and give them an incentive to save for a new car.
- If your children are paying a high rate of non-deductible interest on their student loans, loaning them money at a lower rate of interest can be helpful. Put all the details of the loan in writing and make sure that your children make regular monthly payments to you.
- Some assistance with a down payment for a house is okay as long as your children are willing to disclose their financial situation. Bank of Mom & Dad should ask the same questions as your local banker. Are they paying off their credit card balances every month? What are their fixed monthly debt payments? Add the estimated mortgage payments, property taxes and heating costs to those payments, if it exceed 40% of their gross income then they probably can’t afford to buy the house.
- Help your children save for retirement. Deposit money directly into a retirement account that generates a tax refund. The refund gives them a little extra cash but the compounding effect from investing the money early can increase the chances of a successful retirement.
- Some children will never be financially responsible, skip a generation and open an education plan for your grandchildren.
As a financial advisor, I encountered financial mistakes made by some of my wealthier clients. For example; a client gave his newlywed daughter and son-in-law enough money for the entire down payment for a house. Three years later, they got divorced and the ex-husband walked away with half the proceeds from selling the house including half of the Dad’s down payment.
As a parent, you need to protect yourself, get some legal advice when transferring large sums of money.
Gifts vs. Loans
For U.S. citizens there is a gift tax on sums greater than $14,000 or $28,000 per couple. In Canada, there isn’t a gift tax on money given to adult children. However, transferring investments or property to your children can trigger capital gains tax which must be claim on your tax return. Be extra careful transferring investments to a minor, the parent incurs tax on any interest or dividend income from those investments until the minor turns eighteen.
Be aware that the tax man requires a minimum interest rate charge to loans made to family members. The interest rate varies from year to year. The current rate for Canadian families is only 1% with no time restriction regarding payback.
However, Internal Revenue Service rules are different, in March the Applicable Federal Rate was 0.40 percent for loans up to three years, 1.47 percent for loans of three to nine years and 2.19 percent for loans longer than that. If your children don’t pay it back, it becomes a gift.
Keep in mind that a child in their 30s or 40s has lots of options for generating income; a retiree does not.
By Rico Dilello