Family Bank Loans: The Bank of Mom and Dad

At some point in your parenthood journey, your kids are going to have their own desires. They may even want some financial assistance. Depending on your family structure, they may ask for money directly, or they may find other avenues of financing their dreams. They may ask you for a job, or your help brainstorming ways to be more entrepreneurial. These are all fantastic ways of helping your kids learn valuable lessons. Yet there may be one thing you haven’t yet considered: family bank loans.

Family bank loans, also called intra-family loans, can have a lot of positive effects for your family. While it may not be the right solution for every circumstance or request, it certainly has a place in your family banking system. Loaning money to family, including your kids, can help teach young adults about important financial principles, create financing opportunities that might not otherwise exist, and invigorate your family bank. And when the family bank is thriving, every member of the family stands to benefit.

Why Use Family Bank Loans

If you’re using a family banking strategy with whole life insurance, as outlined in the book Perpetual Wealth, then you know the value of family bank loans. Whole life insurance is a powerful vehicle for savings that outlasts you and can aid in building generational wealth. In short, the cash value of whole life acts as a savings pool that you (and anyone in your family) can leverage. This is what we call an emergency/opportunity fund. Upon your passing, that money can be passed down to other family members, who can then purchase new insurance policies to replenish the leverageable pool of money.

When loaning money to family, a lot of good can occur. The benefits of a family bank loan, as opposed to an institutional loan, are many. Your family can benefit from more flexible repayment terms, a simpler application process, and fewer barriers to entry. For example, a loan from the family pool of money can help your teenager finance their first car. No credit checks are required to loan from the family bank, which also means no need to co-sign and risk your credit score.

This can empower your kids to get their first job and learn about how to pay a family bank loan (or any loan) responsibly. And because you’re in charge, you can set the family bank loan requirements together. As your kids pay the loan back, the family money pool replenishes, all while it continues to earn interest and dividends uninterrupted.

Whole life insurance can create a system of wealth for your family that you can use however you see fit. This means that you can create opportunities for your family that a bank may not be inclined to provide. Your wealth is yours to use at your discretion, and you don’t even have to withdraw funds to use them. The policy loan provision allows you to benefit from the uninterrupted compounding interest.

Family Bank Loan Requirements

When you’re loaning money to family through a whole life insurance policy, you have all the control. This means that you can set up family bank loan requirements as you see fit. In other words, you can create a system that celebrates the values that are important to your family. For example, you may decide that you want to create an application process.

An application would enable family members to pitch why they want a loan. You could include questions like: How would this loan benefit you and the family in the long run? If your teen is interested in getting a car, they may answer that it would help them be responsible for their job and time management. They might also agree to help out with family tasks like picking up siblings from events or running errands. This process can help you reinforce values your family agrees are important, and create peace of mind about loaning money to family.

In addition to an application, family bank loan requirements could include details on how to pay a family bank loan. You might ask your teen how they intend to pay back the loan, how frequently, and at what interest rate. And yes, you should charge interest on your family bank loans! If you have hesitations, remember that the interest benefits your family banking system. The first benefit is that interest paid to your insurance company contributes to company profits and the well-being of the company. Profits are distributed among policyholders in a mutual company. The second benefit is that if you set additional interest, you can replenish funds sooner, creating more available capital for new opportunities.

IRS Intra-Family Loan Requirements

When loaning money to family, there are certain requirements that you must follow. The IRS, for example, has set nominal interest rates you must apply to family bank loans in order to avoid incurring gift taxes or income taxes. This rate is called the Applicable Federal Rate (AFR). These rates are updated on a monthly basis. As of August 2022, short-term loans have a minimum AFR of 2.18%, while long-term loans have a minimum AFR of 2.54%. These rates represent the minimum interest you must charge on an intra-family loan for it to be considered a loan instead of income or a gift.

A Note on Family Bank Loans

Although families often execute loans with nothing more than a handshake and an informal verbal agreement, we strongly recommend that any family loan agreement be documented in a written contract, for several reasons. A document provides a written record for both parties and clarifies the terms of the agreement, including whether any property is pledged as collateral for the loan. 

And, in the event of missed payments or other unexpected circumstances, this information makes settling disputes easier. A contract also provides the heirs and estates of both parties with proof of the existence of the agreement. Since interest received from loans may result in taxable income, this record-keeping is valuable confirmation in the event of an audit. 

How Can We Help?

If you’re interested in learning more about how whole life insurance can facilitate private lending and family bank loans, we’d love to be a resource for you. Prosperity Thinkers is here to help. You can get scheduled with us or send us your questions by contacting welcome@prosperitythinkers.com.

For more education on whole life insurance and family banking strategies, we invite you to sign up for our Prosperity Action Pack. We’ll send you our best resources straight to your inbox, so you can learn more about creating certainty with savings.