Gifts, Advances, and Loans: Balancing an Estate Plan When the Kids Need Money NOW

Estate Planning distributions aren’t always clean and even. Sometimes the kids and grandkids need money during life, and providing it to them can raise questions. (This can also be true when using a Will, but now the probate court is involved.) But whether something is classified as a gift, an advance on an inheritance, or a loan will greatly impact how the final trust estate is divided up. Let me also apologize for a lot of math in this one, but the numbers are what will best explain the differences between gifts, advances, and loans.

First, let’s set up the characters we’ll use to show these principles. Let’s say the parents are John and Jane Doe, and the three children are James, Jennifer, and Jefferson Doe. We’ll also use the fact that John and Jane Doe provided Jefferson Doe $100,000 during their lives that was never paid back before they died, and their net trust estate was $3 million. Next, let’s also acknowledge that human nature often plays into how estate disputes pop up, and people tend to go a little crazy when there is a death and money on the table. If Jefferson asked for and received $100,000 from John and Jane Doe, Jefferson would tend to remember it as a gift that shouldn’t affect his inheritance, but James and Jennifer would likely see the $100,000 as an advance against Jefferson’s inheritance that needs to come out of his share of the estate somehow.

In the revocable living trusts that my offices uses, there is an attached and incorporated schedule where our clients can list money given to a beneficiary as a gift, advance, or a loan precisely so this confusion among the beneficiaries and the trustee does not occur after they have passed on.

Gifts: The simplest of the three options is a gift, if that is what the clients intended. If the $100,000 going to Jefferson was considered a gift, then there is no impact on the division of the trust and James, Jennifer, and Jefferson all get $1 million each. That $100,000 is simply treated as if John and Jane Doe spent the money before they died.

Advances: Now we are getting into some more complex math. When there is an advance on an inheritance in an estate plan, you have to factor in the money that isn’t there anymore. In other words, just because Jefferson already received and spent the $100,000 doesn't mean we ignore it when doing the math. In this case, here is now we have to look at the trust estate:

• $3,000,000 in net trust estate
• $100,000 advance on the estate from Jefferson is added back into the trust calculations, even though the money isn’t actually returned to the trust
• Divide $3,100,000 equally among James, Jennifer, and Jefferson, so each gets $1,033,333.33
• We then subtract out the $100,000 that Jefferson already received, meaning the trust estate is divided as follows:
• James Doe gets $1,033,333.33
• Jennifer Doe gets $1,033,333.33
• Jefferson Doe gets $933,333.33

(We’ll give the extra penny to the Trustee as a reward for doing the math.) The main conceptual item to keep in mind is that if there is an advance on the estate, we have to remember that the money Jefferson received has to be counted as part of the estate in our calculations.

Loans: Loans are conceptually treated differently than Advances, although the math often comes out the same… unless there is actually interest on the unrepaid loan. In this case, let’s use the same numbers for comparison before changing things up a little bit to show how interest can impact the trust estate. If Jefferson received $100,000 from his parents as a loan and never paid it back, and there was a trust estate net balance of $3 million, then the math looks like this:

• $3,000,000 in net trust estate
• $100,000 loan from the estate to Jefferson was never paid back, so we once again add back in the amount that should have been paid back by Jefferson
• Divide $3,100,000 equally among James, Jennifer, and Jefferson, so each gets $1,033,333.33
• We then subtract out the $100,000 that Jefferson did not pay back, meaning the trust estate is now divided as follows:
• James Doe gets $1,033,333.33
• Jennifer Doe gets $1,033,333.33
• Jefferson Doe gets $933,333.33

Loan with Interest: This is the same result. But what about if there was actually interest of 5% compounded annually on the $100,000? Then we have a bit of a different result:

• $3,000,000 in net trust estate
• $100,000 loan from the estate to Jefferson was never paid back and it had compound interest of 5% annually, so we once again add back in the amount that should have been paid back by Jefferson is $162,889.46
• Divide $3,162,889.46 equally among James, Jennifer, and Jefferson, so each gets $1,054,296.48
• We then subtract out the $162,889.46 that Jefferson did not pay back, meaning the trust estate is now divided as follows:
• James Doe gets $1,054,296.48
• Jennifer Doe gets $1,054,296.48
• Jefferson Doe gets $891,407.03

So we can see that the compound interest on the loan that wasn’t repaid has a substantial impact on how the “equal” estate is distributed among the three children. In the case of an advance, interest is not considered in the calculations, but when a loan to a child is involved, it could be with or without interest.

In all three of these cases, it’s important for the trustee to understand a little more about what each of these transactions are and how the math works when the trust estate is finally distributed to the beneficiaries.