• Bridget Sullivan Mermel CFP(R) CPA

How to Loan Money To a Friend or Family Member and Protect Yourself



If you're thinking about loaning money to a friend or family member, there are many things to keep in mind. Or, if you're thinking of borrowing money from a friend or family member, you want to make sure you're doing it effectively. You can protect yourself and your friendship or relationship while helping each other out and saving money.


Bridget Sullivan Mermel CFP(R) CPA and John Scherer CFP(R) talk through their (at least 4) tips for how to loan money to friends and family and bring more meaning to your relationships.


Here are specific places to find different topics:

00:00 Start!

00:50 First tip

01:40 John’s second tip

02:05 Bridget’s first tip

03:05 suggestions for what agreement includes

04:48How to deduct a bad loan on your taxes

06:34 Reporting interest

06:49 Four things to make sure you do

07:40 last tip


In general, make sure that you document what you're doing. Mentally, think of it as a gift, not a loan. Create a document that includes the AFR interest rate. Document your repayments. Report interest. If the person doesn't pay you back, ask them about it and document it.


These are all ways to help your family relationships, your friendships, and to protect yourself. You don't have to be mean! You don't need to harass the person. But if you don't get paid back, don't loan them more money.


Here's Bridget's firm website: www.sullivanmermel.com


John's firm website: www.trinfin.com


For advisors around the US: www.acplanners.org


Thanks for watching and please subscribe!


TRANSCRIPT:


John: Loaning money to friends and family. Does it make sense? How do you do it effectively? Those are the things that we're going to talk about in today's episode of Friends. Talk Financial Planning. And be sure to stick around for the end where Bridget shares one way loaning money to friends could be a tax advantage for you. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.


Bridget: And I'm Bridget Sullivan Mermel. And I own a fee-only financial planning practice in Chicago, Illinois. John, before we start, let's make sure we remind people to subscribe. It helps get the word out. If you're not a subscriber already, please subscribe, and it will help us get a boost on YouTube. So, John, tell me your first tip for loaning money to friends. What are your thoughts on that?


John: Yeah, it's funny, we just had a client ask the question, “Does it make sense? If I do lend money, how do I protect myself?” And so, I've got two or three things that I talk about. And I'll be interested to hear what you have to say.


But the one thing I tell people is, get it in writing. It's all good until something goes sideways, right? I think about this stuff, and it's like, “Oh, they're not going to welch on something I gave them.” But what happens when they get sick, they lose their job, or something goes wrong. Real stuff happens, and you want to lay it out. You do not want to count the chickens before they've hatched. You have to consider what could happen.


If things go sideways, how are we going to handle it? And what are the terms? And make it official. So that's one of the big ones that I have for people. And the other one I think is just assume that you're not going to get the money back. If you can think about it like that, if you're the giver, you should say, “You know what, if they never pay me back, it's going to be a bummer, but it's money I can afford to lose,” or a similar thought process anyway.


So those are the two big things that I talk about with folks. Loaning money is completely legitimate. You can do it, and it makes sense in a lot of cases. What do you talk about when it comes up with folks in your business?


Bridget: Similar to what you're saying, but I want to just flesh it out a little bit first. Yeah, it's fine. It can really help people, and I think people really appreciate it, and it can be a very meaningful way to help somebody out.


One of the things, and I got this from a client whose family was consistently asking her for money—or that's how she felt—and she gave me this tip, is make sure they ask. So sometimes people want to vent about their financial problems, and the person they're listening to just wants to leap in and fix the problem.


John: Interesting.


Bridget: But are they actually asking for or would they appreciate a loan they would have to pay back? And again, that's one of the reasons why putting it in writing is important. It doesn't have to be full of legalese or anything like that but a simple one-pager. This is how much I'm loaning you. This is what the payment terms are. This is how you're going to pay me back. And this is what the interest rate is.


And when we were talking before, you mentioned the AFR, which is the federal rate. It's not high; don't worry. But, again, making it a little official gets to this client's point of, you want to make sure that they're thinking of it as a loan, too, and that we're all adulting here.


John: I just want to unpack a couple of those things, because they are such great points. I don't want to gloss over them. That idea of make sure they ask. At first, I was thinking, “What do you mean?” As I heard you describe it, though, I thought, “That’s right.”


For example, I've got these problems. And maybe the person on the other end is going, “Well, you're asking me to help you out.” When in reality I just want somebody to gripe to and kind of get it off my chest. So maybe the other side is, ask them, “Are you asking for a loan?”


Bridget: That's a good point.


John: Communicate, right? Communicate. How simple is that? But it’s a basic thing that I never would have considered before. That's fantastic. And thanks for bringing up the Applicable Federal Rate. You have to charge an interest rate to make it legal. There's a minimum amount. I think it's under 1% for a short-term loan these days. You can look it up. But charge something. So that's one of the things that make it official, then it's all on the up and up. So that's great.


Bridget: Yeah. And so, then this is a question that I ask people when they're filing their taxes. Have you loaned anybody money who hasn't paid you back? If you make it official and the person doesn't pay you back, you can deduct loans that don't get paid back on your taxes. There's a little bit of rigmarole to go through, but not that much. And so, you want to make sure that you have a document that shows things, like this is a loan; these are how they started paying me back.


And if they don't pay back, you want to document what you do to try to get the collection. If you just blow it off and never mention it again and the IRS comes and asks you about it, that's going to be a minus. You want to have some collection effort. It's not like you have to call a collection agency and turn it over to them or sell it to them. But having some effort to collect is a positive. The IRS is trying to sort out: Is this a loan or is this a gift?


John: Right. I can't deduct my gift. I give you some money. I can't take a deduction for it. It's got to be legit, right?


Bridget: Right. Exactly. So that's what the IRS is trying to figure out. And so, making it official that this is a loan, not a gift is what you want to do when you're setting it up. And if you're going to lose, that doesn't mean you have to be mean.


John: Yeah, right. You have to follow the rules, but you don't have to be mean. It's just documentation and it got to be legit.


Bridget: Yeah.


John: You mentioned that to me, and I thought, “What a great idea that I've never really considered.” If a bank loans money to somebody and they don't pay it back, the bank writes it off, right? It’s a legitimate thing. And on the flip side, too, let me point out that when they pay interest to me, I have to report that interest on my tax return, right? Just like when I leave money in the bank.


So, you have to report interest on your loan on your taxes. But then if you don't get paid back, you can write it off and that can be several hundred or several thousand dollars. If we go back to the guidelines, number one is document it. Number two is don't loan money are not willing to lose. Kind of think of it in terms of, “All right. If it ends up being a gift or a loss that’s okay.”

But if we do that, then why not take advantage of it from a tax standpoint? I was expecting to get some return on this loan, but I didn't get it. And just like any other investment, you take a loss on it and make sure that you have a reasonable interest rate that follows the guidelines. Do those four things.


Bridget: You’d rather get paid back than deduct it on your taxes. So for you, because getting paid back is better than deducting it on your taxes, deducting it on your taxes is just kind of trying to recoup something, but you're not recouping all of it. And then the last tip I would have is if you've loaned somebody money and they haven't paid you back, don't loan them money again until they do pay back.


John: Yeah, fool me once, right?


Bridget: Yeah. It seems basic, but it’s important. And you can bring that up if they ask you again, because that's just indicating that they're having some kind of personal problem. That is maybe beyond your ability to solve. And you can help them out in some other way.


John: That's awesome. I think that's a great place to wrap things up here. Thanks for sharing things. I enjoyed the conversation, Bridget. Again, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin. I'm with Bridget Sullivan Mermel who runs a fee-only financial planning practice in Chicago, Illinois.


And I wanted to remind everybody that both Bridget and I are members of the Alliance of Comprehensive Planners. If you like what you hear on our show and would like to find an advisor in your area that has a similar thought process, go to acplaners.org.


Bridget: And don't forget to subscribe!


John: Thanks, Bridget. Bye.


At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation.We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.

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