Recently, a client came to me with a difficult dilemma. He was retired and living comfortably but didn't have much room in his budget for additional expenses. His son was a high-ranking executive with a midsize company. He was married, with three children, all of whom were in private school in New York City. The son lost his job as a consequence of restructuring.
He was having difficulty finding another position at anything close to his prior income. He had been looking without success for more than six months. He was at a point where he could no longer meet his substantial monthly expenses. He asked my client to provide the funds necessary to maintain his lifestyle and the education of his children, until he was able to "land on his feet."
My client could afford to make these payments for a limited period of time but his retirement plans would be jeopardized if the time period was prolonged and if his son did not pay him back. He asked for my advice.
For many Americans, the goal of helping children and grandchildren pay for their education and preserving wealth to leave to their children is an important goal. Unfortunately, the 2008 recession reduced the confidence of investors in their ability to meet those goals. According to a report prepared by Ameriprise Financial (AMP), only 24 percent of those surveyed in 2012 were "very confident" they could help with education and only 16 percent had confidence in their ability to leave an inheritance to their children. What is more troubling is the finding that only one-third of those surveyed felt very confident in their ability to provide adequately for themselves and their family.
My client had never discussed his finances with his children. He is not alone. More than one-third of the parents of boomers believe they haven't adequately discussed finances with their children, according to the Ameriprise study.
The father and son were both in the dark regarding the finances of the other. It was important for the son to understand the limitations of his father's ability to make additional payments and the consequences of not getting repaid. It was equally important for the son to disclose the details of his expenses, the amount of the shortfall and his prospects for paying back the money he was requesting. Full disclosure builds trust, mutual understanding and empathy.
Here's what I advised my client to do:
1. Consider alternatives. After full disclosure, there should be a process of evaluating the request and looking for alternatives. There is an obvious difference between loaning money to pay for medical expenses and paying for an extravagant lifestyle. It is often difficult for a parent to tell a child to reduce expenses when the child is asking for a loan. However, alternatives should be considered. Is it possible to reduce expenses, which would lower the amount of the funds needed? Some discretionary expenses (like excessive shopping, organization dues and expensive cars) can easily be reduced. It is entirely reasonable to review these expenses before making a loan.
2. Involve a third party. A request for a loan is an excellent opportunity to involve a third party -- like an accountant, financial planner or adviser -- to assist with this process. A third party does not bring the emotional baggage of a family member. When my client sought my advice, I arranged for a meeting with him and his son. I asked his son to bring in his financial records so I could review them. I discussed his job prospects and questioned his projections of when he was likely to find another position and what his new salary was likely to be. I was able to deflect the tension that would have been caused if the father had probed into these areas. I was also able to explain to the son how vulnerable his father would be if the money loaned was not repaid.
3. Structure the loan. My client could not afford to make a gift to his son. It was necessary to structure this transaction as a loan. Loans between family members can be tricky. Even if you have all the legal documents in place and everyone understands the terms, the reality is that a father is unlikely to sue his son in the event of a default. To avoid this issue, I suggested the son take out a loan from the bank used by the father and had the father guarantee the loan. Payments would be made directly to the bank. Structuring the loan in this way had a number of benefits, including making the transaction more formal and businesslike.
This story had a happy ending. The son got a new job at a salary close to the one he had at his prior job. He has not missed any loan payments. His relationship with his father was preserved, even enhanced, by this experience.
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, "The Smartest Sales Book You'll Ever Read," will be published March 3.