There is no easy way to lend to family and friends, as was most recently demonstrated by the Supreme Court decision regarding the Lipson case on Thursday. Advisors who have clients engaged in personal lending have to walk a fine line between offering complex financial advice and steering clear of emotional issues associated with them.
A recent poll commissioned by Investors Group of more than 2,000 Canadians found that 64% have loaned or borrowed more than $500 from friends or family, and of that percentage, 26% report that the loans were not fully repaid.
Normally, rationale can prevail in many financial issues, but Debbie Ammeter, a vice-president at Investors Group, says rationale has little to do with why loans are usually made to a loved one.
“You have to recognize and respect your client’s wishes. The advisor’s role is to offer personal advice on the person’s information,” she says.
That said, advisors shouldn’t be shy about stepping in with their opinion about how their client is deploying money, Ammeter says. They bring a much needed objective perspective to the situation. She advocates that advisors help their client formalize any type of lending arrangement they engage in.
The survey found that 83% of Canadians who had loaned or borrowed funds from someone in their personal circle did so without a written agreement. Half the respondents (51%) said they approached a friend or family member rather than a lending institution because they would pay either less or no interest on the loan.
“Separating ‘business’ arrangements from personal matters may seem uncomfortable to both lender and borrower, especially if the situation doesn’t seem formal,” Ammeter says. “But loaning money to a loved one doesn’t preclude asking for specific loan conditions or a pay-back plan and these can reduce the potential for disagreements and long-term future rifts.”
Jeanette Brox, a CFP based with Investors Group in Toronto, has numerous clients who have felt obliged to lend to love ones. Formalizing the agreement is always top of her list. She finds the situations frustrating at times, because she has a relationship with the lender, but often not with the borrower.
Generally she tries to ascertain the viability of a borrower being able to pay her client back, but when it comes to an immediate family member like a son or daughter, emotion usually outweighs reason.
A few years back, Brox had one retired client who gave a $50,000 loan to her adult son, the owner of a floundering small business. Brox helped the client create a promissory note, but the son has never paid back a penny for the loan, and the mother refuses to call it in.
“It’s hard for parents not to give their kids money. It’s hard for them to enforce the lending practices. I gave her the advice to do so; she’s decided not to take it,” Brox says. “Given current market conditions it would be nice to have some of that money back.”
Eventually, Brox says the client has changed her will, so that the amount of the loan will be forgiven when she passes away, and the amount will be deducted from her son’s inheritance.
Sometimes lending within the family, particularly to a spouse, is part of a strategic plan. Peter Merrick, a CFP and president of Merrick Wealth, has taught personal lending strategies as part of the CFP curriculum at various institutions.
He notes that, because of tax-attributions rules #&151; like the kind that tripped up the Lipsons #&151; it rarely pans out for clients.
If someone lends money to a spouse, any growth on the original principal loan will still be attributed to the lender, Merrick says. An investment loan from one spouse to the other to reduce capital gains only makes sense if there is a long time horizon for the spouse to grow his or her own earnings.
“If I lend money to my wife, the only part she’s taxed on is any growth on the earnings she’s gained the past,” he says. “If you look at it going 20 years forward, the growth on the initial loan (and lower marginal tax rate) might be much greater than the taxes that were attributed to me.”
Generally speaking, Merrick advises lending to a spouse only to reduce the amount of assets that could be exposed to creditors. He does a lot of wealth planning for businesses and says eventually they always have their assets under threat through either legal action or financial troubles.
“If you’re a business owner, somebody at some point is probably not going to be happy and is going to take a swipe at the business. You might want to transfer some assets via lending over to the spouse, who has no interest in the business,” he says.
Ammeter highlights that a personal lending situation can be a great prospecting opportunity — more likely than not, the borrower needs financial advice.
“With more people getting laid off these days, that could prompt more of these situations. Advisors need to remember, there are really two parties to a loan, and there are probably financial issues with both the lender and borrower,” she says.
Brox secured another personal loan by having the borrower, a best friend of her client’s, take out an insurance policy with a death benefit equal to the amount of the loan.
“We told him these are the terms of the loan, but what happens if you die? We did a small life insurance policy for $50,000 if he died,” she says.