How to handle loans

How to Handle Loans in Your Estate Plan

We hear a similar story from clients all the time. Maybe you have done this: you advanced some money to one of your children, and they are (or are not) making payments on the loan. How do you want to handle loans in estate plan?

There are no universal rules

First off, let’s get one item out of the way. There is no requirement that you make your beneficiaries repay loans, and there is no prohibition against doing so. You get to do what you want. We’re just interested in clarity.

Why is it important to be clear? Because your children don’t actually get along as well as you think they do. Do you think each one knows how much money you have loaned to the others? Do they also know whether interest has accrued, what interest rate to apply, and what loan date to start with?

Maybe you didn’t actually “loan” the money at all. Maybe you actually intended it to be a gift, with no strings and no repayment obligation. That’s fine. But even though there is no repayment requirement, you get to reduce that child’s share by the amount of the gift if you want to. Again, no requirement.

What do we usually see?

Not sure how to handle loans in your estate plan? We can tell you what we see most often. But we want to caution you that you are not required to take the most popular approach — or any particular approach.

We ask clients whether they have made substantial gifts or any loans to their intended beneficiaries. The reason we ask: we want to make sure we know what you want to do about it. You hadn’t thought about it? We bet your other kids have, and we want to head off future disputes.

So maybe you advanced your oldest daughter $20,000 to help her make a down payment on her home. She thanked you, bought the house — and then started paying back the money, even though you told her she didn’t need to.

Meanwhile, you paid to put your younger daughter through college and professional school. You estimate that her education cost you about $100,000 over the years. You never expected her to repay it, but now that she has a professional position you’re surprised that she never offered to repay any of it.

So what do you do? Do you want to reduce the younger daughter’s inheritance by $100,000 because it would be more fair? Or just let it go?

Most of our clients walk away from those equalization ideas. It can be too hard to calculate what would be “fair” (should the younger daughter’s reduced inheritance allow for interest not paid, or should the older daughter get an additional share to reward her good behavior?).

What do you want to do?

Maybe you are like the majority of our clients, and you want to forgive any loans (or advances). We encourage you to include language in your will or trust, just to make it clear.

Or perhaps you prefer to “equalize” the inheritances you leave to your children. In that case, we’re going to ask you to articulate what you think would be fair, and why. We might include that language in your estate plan, but we’d like our notes to reflect what you were thinking in any case.

You get to decide how to handle loans in your estate plan, but we do want you to think about it and make it clear. One key reason: we are eager to have your intentions clearly spelled out. We read an appellate court decision the other day that explained how important that can be.

In 2006 Sarah Walker wrote a will leaving her entire estate equally to her five children. She added, though, that each child’s share should be reduced by “any debt owing to me by any heir at the time of my death, to come out of that child’s part.”

When she died in 2016, one daughter owed her over $85,000. That daughter argued, though, that her mother’s will could not incorporate a separate debt to reduce her bequest. The judge (in a Mississippi case) agreed, and ordered that Ms. Walker’s estate be divided equally among the five children.

The Mississippi Court of Appeals disagrees

Ms. Walker’s personal representative appealed, and the Mississippi Court of Appeals reversed the order. The appellate judges agreed that Mississippi law generally does not allow any information outside the will itself to modify the terms of the will. But in this case, Ms. Walker had actually written out the amount that each of her children had borrowed, and her intent was clear. The only question was whether the list was clearly her list (and whether any additional loans or repayments would change the dollar amounts).

Ms. Walker’s daughter also argued that any money her mother had loaned her was well over three years before her death. Ms. Walker would not have been able to recover those loans if she had filed a lawsuit before her death. But the appellate court ruled that to be irrelevant; Ms. Walker and her estate were not trying to recover the loans, but her intent about how to handle loans had been clear. Her daughter’s inheritance should be reduced by the remaining value of any such loans. The appellate judges remanded the probate case to the trial judge to determine the amount of any outstanding loans. Estate of Walker v. Brown, May 19, 2020.

What lesson is to be learned?

First of all, state laws differ. It seems (to us) unlikely that an Arizona probate court would have reached the same conclusion as the trial judge in the Mississippi case. But we would anticipate the same outcome at the appellate level. If you want to specify how handle loans in your estate plan, you have every right to do so.

But we do think it’s important to be precise. If you think your daughter owes you $85,000 (as Ms. Walker did), we’d love to have that information carefully detailed and, ideally, included in your will or trust. What about changes in the dollar amount (if, for instance, your daughter pays off some of the loan, or borrows additional funds)? We’d like you to update your will or trust periodically to reflect current figures.

But ultimately, it doesn’t matter whether you have calculated precisely or not. If you want to say “and my daughter’s share will be reduced by $85,000 because that’s about what I think she owes me” (don’t use exactly that language, please — but you get the point), that’s what will happen. If she later pays the entire loan back, her distribution may still be reduced — unless you update your documents. Meanwhile, if she’s making periodic payments — good for you! And let’s have your estate planning documents detail how that calculation should be made.

OR, you can just forgive any loans any of your beneficiaries owe you. That’s easier, but perhaps not as fair. But (have we mentioned this before?) you get to do what you think is right.

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