How intrafamily loans can fill the gap in education financing

Editor’s note: This is the final article in a six-part series on paying for education using smart financial and estate planning. Below are links to previous articles on direct tuition payments. 529 plansCoverdell education savings accounts, UTMAs and irrevocable trusts.

Student loans are a common way to finance education, but many may not realize that the source of these loans can come from family members, not just the federal government or financial institution. Although less common, structuring an intrafamily loan may be the best way to help pay for education. This is especially true during periods when intra-family interest rates are low.

For it to count intra-family loan and not a gift, the accrued interest must not be less than the minimum Applicable Federal Rate (AFR) is set by the IRS every month. If the AFR rate is lower than the federal student loan rate, this may be a good alternative if you want to help a family member without paying for their education with a gift.

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The creditor family member can set the terms of the loan, allowing for as much or as little flexibility as possible in the repayment plan. If at any time the lender forgives part or all of the loan, any loan forgiveness amount turns the loan into a gift, making it subject to federal law. gift tax laws. Interest earned on a loan is taxable to the lender and is not considered deductible to the borrower.

Unlike formal loan agreements with a financial institution, household loans avoid the hassle of credit checks and extensive paperwork, making them more accessible to people with limited credit history or income. In addition, the loan can be refinanced at any time. However, the disadvantage is that they may lack legal protection or recourse mechanisms in the event of default or disputes. Any breach of trust can strain or, in the worst case, destroy family relationships.

Advantages of intra-family loans:

Intrafamily loans are often issued at lower rates than federal ones. student loans (but must meet the AFR rate set by the IRS)
The payment plan may be flexible depending on the terms set by the creditor family member.
Avoids the hassle of banking bureaucracy and extensive red tape for loan documents.

Tips to keep in mind:

Loan forgiveness converts the loan into a gift, making it subject to federal gift tax law.
May lead to family discord if the loan is not repaid

Exploring family loans to finance education offers a flexible and possibly cheaper alternative to traditional student loans. Complying with the IRS set interest rates and by customizing your repayment terms, you can provide financial support while avoiding the hassle of a bank or federal student loan program. However, be aware of the risk of tax consequences and possible strain on family relationships if the loan is not repaid. Weighing these factors can help you decide whether a family loan is the right choice for your situation.

End of the series

There are many ways to finance a child’s education and there is no one-size-fits-all solution – each family must consider its own financial situation, tax situation, estate planinvestment plan and/or family/personal dynamics to determine what is best.

Here’s a snapshot of the six options we discussed in this series:

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A snapshot of the options discussed in this series of articles
Row 0 – Cell 0	Direct tuition payment	529 Plan	Coverdell ESA	UTMA	Trust	Family loan
Tax-free investment growth	No	Yes	Yes	No	No	No
Contributions are subject to gift tax	No	Yes	Yes	Yes	Yes	Yes, if you forgive
Can only pay for specific education expenses	Yes	Yes	Yes	No	No	No
Deposit limits	No	Yes	Yes	No	No	No
May cut financial aid	Yes	Yes	Yes	Yes	Yes	No

Many families use a combination of methods and means to finance education, especially when multiple generations are involved. For example, parents can create a 529 plan to pay for their children’s college education, while grandparents pay for a private high school education by paying tuition directly to the school.

As an investment office serving multi-generational families, all with different circumstances, we are happy to help you explore options for paying for the education of future generations.