Low-Interest Loans To Family Members – What To Know

A byproduct of the COVID economic crash is extremely low interest rates…orchestrated by the Federal Reserve. One long-standing family wealth transfer strategy is making low-interest loans to family members. For loans between family members, you are required by law to charge a minimum interest rate based on the monthly published Applicable Federal Rates (AFR). These rates change monthly and are currently at very low levels.  For May 2020:

 

AFR short-term rate: 0.25% (loans under three years)

AFR mid-term rate: 0.58% (loans 3-9 years)

AFR long-term rate: 1.15% (loans longer than nine years)

 

Here is how the strategy might work:

Example #1: A parent wishes to make a $100,000 low-interest loan to a child to start a business, and they expect repayment within nine years.  They create a note using the AFR mid-term rate of 0.58%. The annual interest payable from the child to the parent would be $580. If desired, the parent could use their annual gift exclusion to forgive the interest. They could also forgive a portion of the principal annually (up to $15,000 per year per parent) if desired…and avoid using any of their lifetime annual exclusion amount ($11.58 million for 2020).

Example #2: If the parent wanted to help a child buy a home and use a long-term loan, of say 30 years, using the AFR long-term rate, the annual interest would only be $1,150.

 

Follow The Welch Group every Tuesday morning on WBRC Fox 6 for the Money Tuesday segment.

 FOX 6 TALKING POINTS

Great Time for Making Loans to Family Members

  • Fed rule: Must charge interest when loaning family members money
  • Fed has reduced rates due to COVID
    • 0.25% short-term (under 3 years)
    • 0.58 mid-term (3-9 years)
    • 1.15% long-term (more than nine years)
  • Example: Parent loans $100,000 to a child to buy home
    • $1,150 annual interest
    • The parent uses annual gift exclusion ($15,000) to forgive interest (and principal)

 

 

Stewart H. Welch, III, CFP, AEP, is the founder of THE WELCH GROUP, LLC, which specializes in providing fee-only investment management and financial advice to families throughout the United States. He is the author or co-author of six books, including  J.K. Lasser’s New Rules for Estate, Retirement and Tax Planning- 6th Edition (John Wiley & Sons, Inc.); THINK Like a Self-Made Millionaireand 100 Tips for Creating a Champagne Retirement on a Shoestring Budget. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by The Welch Group, LLC (“Welch”), or any non-investment related content, made reference to directly or indirectly in this article will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. More information about The Welch Group and important Disclosures can be found on our website. Consult your financial advisor before acting on comments in this article.