As families gather for the holidays, those with more financial assets than others may feel the urge to help out a niece, nephew or other relative. In fact, the rich relative has become a popular archetype in literature and pop culture, from the eccentric and free-spirited Auntie Mame (the inspiration for the bestselling 1955 novel and the musical “Mame”) with a soft spot for her nephew Patrick to Jane Eyre’s uncle leaving his fortune to her to Uncle Phil on the popular TV show “The Fresh Prince of Bel-Air” taking in his nephew, played by Will Smith.
[See: Prepare Your Finances for the Holidays.]
This dynamic happens in real life, too. “Given the different states of the economy and college costs and medical costs, we run into it very often,” says Kim Dula, partner in accounting firm Friedman LLP. “The mom and dad of the family may be the middle of financial difficulties, so it may be their brother or sister helping out nieces or nephews,” Dula says. In many cases, this may be a professional aunt with no kids or a professional uncle with no kids with extra income to help a family member buy a home, fund their education or just because they can afford it.
But mixing family and finances can be fraught with unintended complications. Here’s a look at questions to consider before giving money to a family member (or accepting monetary gifts), especially those who aren’t direct descendants.
Can I afford to give away this money? Just as parents may feel obligated to send their kids to college or give them a better life than they had, other well-intentioned relatives may feel similar pressures, especially if they’ve done well financially and see other family members struggling.
But before writing a check, make sure you can truly afford to part with that money. Even if it’s intended as a loan, make sure that late repayments won’t cause financial pain and strain the relationship. “Maybe today the gift may be OK, but how about 10 years down the road?” Dula asks. “Where are these funds coming from? I knew a gentleman who was considering pulling money out of his retirement fund to help his nephew with college costs,” explains Dula, who encouraged him to look at alternative ways to help so he wouldn’t trigger early withdrawal penalties or deplete funds he may need in the future.
Is this a one-time gift, or do I plan to provide ongoing support? Instead of writing a check without explanation, discuss the context and purpose of the gift with the recipient to avoid a misunderstanding. For instance, do you plan on helping your niece or nephew throughout college or just to get him or her set up during their first year? Does the recipient know that you intend your gift to help them buy a first car or home? “When you’re having these conversations, discuss it as serious transactions so that expectations are known on both sides,” Dula says. If a relative comes to rely on your generosity, that can create a sense of entitlement or spur them to take on bigger expenses than they can afford on their own, so be clear about your intentions.
[Read: Financial Conversations You Should Have During the Holidays.]
How will I minimize resentment from other family members? If other family members find out that you’ve made a sizable gift to one person in secret, that can strain the dynamic between your relatives. “Almost invariably that word gets out amongst the family, and that creates bad feelings,” says Clarence Kehoe, partner at accounting firm Anchin, Block & Anchin. He recommends being transparent with other family members rather than giving support on the sly. “Sometimes people are understanding and they get it,” he says. “If I had a situation where an uncle spent a lot of time with a niece, that’s an easier situation when people see what’s going on.” Family members might also be understanding if someone is truly down on their luck and needs money to avoid foreclosure or pay for major medical bills. When family members know the money is being spend on life-saving medical treatments, they’re less likely to feel jealous since they don’t have that same need.
What about the tax implications? Whether you’re giving money during your lifetime or planning to leave money to family after you pass away, you’ll likely want to discuss the tax implications with your accountant. The IRS offers a gift tax exemption of up to $14,000 per year per recipient, so if you’re giving more than that amount in a single year to someone who isn’t your spouse, you’ll need to file a gift tax return. Even for smaller amounts, “it’s always a good idea to have [a gift tax return] on file just to show that you’re paying attention to it,” says Deborah Meyer, CEO of WorthyNest, a fee-only financial planning firm based in greater St. Louis. “At least notify the tax preparer, and let them make the determination if a tax filing is required,” Meyer adds.
If you’re married, each of you can give up to $14,000 for a total of $28,000 per year. And if the recipient is married, you and your spouse can each give $14,000 to each spouse for a total annual gift of $56,000. “If they have kids, you could gift even more,” Meyer says.
In some scenarios, you may be able to gift even more money. For instance, if your niece or nephew has to pay substantial medical bills, you could pay those bills directly to the hospital or medical provider without triggering gift tax issues. College planning is another area where you may be able to contribute more for a relative. Let’s say you contribute five years of the annual gift exclusion at one time to a 529 plan ($14,000 times five years, so $70,000). “That money would sit and compound quicker,” Kehoe explains. Alternately, you could pay tuition directly to the educational institution and avoid gift exclusions altogether.
A tax or estate planning expert can also advise you on strategies for minimizing estate tax on inherited assets. Meyer points to a client who converted a traditional IRA to a Roth IRA during her lifetime and made her niece and nephew the beneficiaries. Since she’d already paid tax on the IRA investment appreciation, “the niece and nephew will not pay tax on inherited Roth IRA withdrawals during their lifetime,” Meyer explains.
[See: Your Ultimate Holiday Tipping Guide.]
If you’re the beneficiary of a gift from a wealthy aunt, uncle or other relative, then they’ve hopefully done this tax planning for you. The more affluent relative is likely to have an accountant or financial advisor, so the planning typically falls to the benefactor rather than the recipient. Plus, gifts are not taxable as income. But if you receive a lump sum that’s more than you need for a specific purpose such as college or a home purchase, consider consulting a fee-only financial planner on how best to use that money.
As Dula points out, the goal is to help a relative without straining the relationship. Considering these factors can help minimize taxes and resentment while maximizing the gift’s positive impact.
More from U.S. News
8 Financial Gift Ideas for Children
8 Times to Talk to a Financial Advisor
What to Know Before Giving and Accepting Money From Relatives originally appeared on usnews.com
