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“The Bank of Mom and Dad” vs. Retirement

“The Bank of Mom and Dad” vs. Retirement

March 08, 2019

The Federal Housing Administration recently published data showing that, for the fiscal year ending September 2018, 26% of first-time home buyers received financial assistance from relatives, usually parents, to come up with the down payment. This compares to 22% of first-time buyers who had help from their families in 2011.

Some analysts see this increase in family support as indicative of a larger trend: Young adults are more reliant on their parents for financial support, and for longer periods. While the desire to help their adult children get a financial leg up is understandable, some experts think it might be time to pull the plug on what is often referred to as “The Bank of Mom and Dad.” “We love our kids, but they can ruin retirement,” says Theresa Ghilarducci in a July 2018 article. Ms. Ghilarducci is an economics professor who has often appeared before Congress to discuss the poor state of retirement saving in the United States. To buttress her reluctance to provide financial assistance for adult children, Ghilarducci cites a report from NerdWallet which finds that “A parent’s retirement savings could be $227,000 higher if they chose to save the money that would otherwise go to their child’s living expenses and tuition.”

 The same study reports that a significant number of parents are providing more than a down payment for their adult children: - 28% have paid tuition or student loans - 56% have bought groceries - 40% are paying for their children’s health insurance - 21% are paying rent for children living outside of home Ghilarducci isn’t saying parents shouldn’t offer financial assistance to their children. But some parents are “sacrificing their finances in old age by giving money to their adult kids,” and from her perspective (which is admittedly focused on retirement), “One of the best things you can do for your kids is take care of yourself.”

For Ghilarducci, taking care of yourself equates to having “$2-3 million saved for retirement” before offering to help with a down payment. Since the professor also notes that the median retirement savings for upper middle-class Americans between the ages of 55 and 64 is around $100,000, her conclusion is clear: Many Americans would be better off closing their Bank of Mom and Dad. How do you prioritize your children’s financial well-being against your own? It can be tough.

Thinking About the Bank of Mom and Dad

 Be proactive about the topic of financial assistance to adult children. Don’t wait until Junior comes to you with a financial “emergency/opportunity” that only you can solve. Decide in advance what you will or will not do. A bit of Internet research finds the Bank of Mom and Dad is an interesting subculture in personal finance. It has its own acronym (BOMAD), several distinct philosophies, and a variety of strategies. Some things to consider:

Is Your BOMAD a Charity or a Business?

A pivotal division in BOMAD thinking is whether intrafamily financial assistance is an act of charity or a business transaction. As an example, consider a down payment on a home. Sometimes, the assistance must be charity. A lender may require any down payment assistance to be classified as a gift, because a loan would further increase the adult child’s indebtedness and perhaps make them ineligible for a mortgage. Money affects the relationship dynamics. King Solomon noted in his Proverbs that “just as the rich rules over the poor, the borrower is slave to the lender.” How many parents or adult children want a loan in the relationship, especially one that emphasizes an imbalance of financial power? If you don’t want your children financially obligated to you, better perhaps to give them money instead of loaning it. Conversely, a family might see a loan as a familial and financial “win-win,” a way to help a son or daughter while also improving the parent’s finances. Suppose the parent liquidates some low-yield savings to make a loan to a child, perhaps at a rate less than an institutional lender. For the parent, this rate might be better than the earnings from savings. This transaction allows the money to be used today for the children, but also eventually replaces it, with a profit in the parent’s portfolio, and decreases or eliminates the lost opportunity costs that would have occurred if the money was simply a gift.

Planning for the Bank of Mom and Dad

Depending on your decision to operate as a charity or a business, here are some specific recommendations, culled from a number of websites and white papers.

 If your BOMAD is a charity…

 Determine what you can afford to give. It’s easy to get parental, and just say yes to every request and, for the moment, feel good about helping out. A better approach: consult with your financial professionals and determine a dollar amount that can be given away without jeopardizing your other financial objectives. Clarify your objectives for helping. Identify items for which you would give (a down payment on a house) and wouldn’t (a trip to Disney World). Hopefully, your gifts are catalysts for a better future, not just band-aids on unresolved issues.

If your BOMAD is a business…

Have your children first seek institutional assistance. Going through the loan application process can make them appreciate your willingness to help and inform you of their ability to repay. Put the loan in writing and keep good records. Treat this like a business transaction, with the terms clearly defined. This is essential for resolving legal issues, settling estate and inheritance distributions, and clarifying tax consequences for both the parent and child.  Secure the loan. Especially if the loan is for a home purchase, the agreement should confirm the lender’s interest in the property should the child default. Understand the tax consequences. Intra-family loans are not exempt from tax laws. A parent may charge a below market rate of interest, but must be aware of the “applicable federal interest rate,” and how it may trigger imputed interest or gift taxes. If at some point the loan balance is forgiven, the IRS may consider the forgiven amount a gift, and subject to gift taxes. (Conclusion: it is best to seek professional tax assistance.)

A BOMAD could change how much you save and where you save. Because of the penalties for early withdrawal, 401(k)s and other qualified retirement plans may be sub-optimal places for BOMAD saving. Look to your financial professionals for other options, ones that have better tax treatment on withdrawals, and favorable liquidity characteristics.

The Bank of Mom and Dad has long been an essential resource for young adults to transition to financial self-sufficiency (a 2015 white paper called it “a source of comfort for everyone”). But well-meaning parents can unnecessarily disrupt their own finances by imprudent disbursements to adult children. If you’re going to be the Bank of Mom and Dad, make sure your plans for operation are in place well before you open for business (or charity).

Lifetime Financial Growth, LLC is an Agency of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Securities products and advisory services offered through Park Avenue Securities LLC (PAS), member FINRA, SIPC. OSJ: 244 Blvd of the Allies, Pittsburgh, PA 15222 (412) 391-6700. PAS is an indirect, wholly-owned subsidiary of Guardian. This firm is not an affiliate or subsidiary of PAS. 2019-75477 EXP 2/21

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