Compensation to sibling for advance on inheritance?
April 20, 2018 8:47 AM   Subscribe

What's the fairest way to compensate one sibling when the other sibling has received an advance on their shared inheritance?

Sibling A has received a $100k loan from parents to purchase a house. The loan can be paid back to parents, with low interest (say 2%), upon eventual sale of the house IF Sibling A wants (parents don't really care when/if it gets paid back). If not, 50% can be shared with Sibling B when parents' estate is divided between the two. Youngest parent is 65 so this might be quite some time from now. The estate will be significantly larger than the share of the loan so Sibling A won't be forced to sell their house to make Sibling B whole.

What are the fairest terms for Sibling B? Sibling A would like to be cognizant of the fact that parents aren't offering the same deal to both, for various reasons. Sibling A was thinking of doing a "greater of" calculation: $50k with interest (what rate?) OR a proportionate share of Sibling A's home value (so if the purchase price is $500k, then 10% of whatever the home is valued when the estate is divided). This may be slightly hard to track if Sibling A sells the house and buys another, but not impossible.
posted by acidic to Work & Money (11 answers total) 3 users marked this as a favorite
This would be much simpler if the loan was phrased as a callable loan (callable upon death of the loaner) with a 0% interest rate, which is what it actually is. Sibling A owes the entirety of the remainder of the loan to the estate, unconditionally. If the estate is significantly larger than the loan, this will not impose a repayment issue to Sibling A.

Realistically, if the terms are "pay it back if you want", the terms are actually "this is a 0% interest loan" because no rational person would pay back the loan until the loan is called upon death. Hence, the difference between the currently common 30-year interest rate and 0% is the compensation to Sibling B. A quick Google search suggests that's around 4.5%-4.6% (APR), so for complete equity, Sibling B should expect to receive ~4.5-4.6% interest in cash for the term of the loan. Conveniently, this is also how the IRS views the scenario - the difference between market rate interest and the actual interest is a gift.
posted by saeculorum at 9:01 AM on April 20, 2018 [11 favorites]

Taking this a bit further, Sibling B should not be accountable a the share of Sibling A's home value. Preferably, this option is avoided, as it is investing in a sibling, which seems morbid, at best. At the very least, Sibling B should be accountable for more than a proportionate share of the house, since that is equivalent to Sibling B investing in Sibling A's house without any of the benefits of actually owning Sibling A's house - ie, they don't get to live in it, claim tax benefits, etc. If Sibling A's house value goes down (which certainly can happen), this means that Sibling A would have had the benefit of a place to live and the equity in the house, whereas Sibling B would still have had to pay for a place to live and received less money due to Sibling A's poor investment.
posted by saeculorum at 9:06 AM on April 20, 2018 [1 favorite]

The house valuation at the time of sale isn't really relevant. The parents are effectively giving Alice (let's call her) a certain amount of money, on certain terms; what Alice does with the money is her concern. If she decided to set it on fire Joker-style, or bought a valuable stock and quintupled her money, that's her risk and her reward.

Effectively, what seems fairest to me is to figure out what a reasonable interest rate would be on this loan. Then, upon the death of the parents, Alice has effectively already received the following amount from the estate:

(loan principal) + (reasonable market interest on loan) - (repayments)

Bob should then receive this amount from the estate, and then the remaining assets should be divided equitably. Note that if Alice has paid back the loan with interest (at market rate), then she's made the estate whole, and so Bob doesn't need to receive anything extra to make things fair.

On preview, this is basically what saeculorum is suggesting.
posted by Johnny Assay at 9:07 AM on April 20, 2018 [2 favorites]

At the "First National Bank of DrGail's Parents", loans were offered at an interest rate comparable to what the money would otherwise earn in whatever investment the money was drawn from. A note was always signed to that effect. Hence, Sibling A's share of the estate would be one-half less whatever the amount remaining to be paid on the loan would be.
posted by DrGail at 9:09 AM on April 20, 2018 [3 favorites]

(loan principal) + (reasonable market interest on loan) - (repayments)

This still biases towards Sibling A because Sibling A's interest payments will be due upon death, not continuously. A real bank would receive interest payments continuously, not all upon loan payment. Money now is always worth more than money later. A more reasonable equation would be:

(loan principal) + (reasonable market interest on loan)*(interest rate due to investment of interest) - (repayments)

This is similar to what DrGail notes - a real investor would be investing with those payments, so Sibling A should pay for that opportunity cost.
posted by saeculorum at 9:15 AM on April 20, 2018 [2 favorites]

You will lose 50% of the interest on 100k when you someday inherit. Let's say you inherit in 30 years. If this is an amount of money that is genuinely a big deal to you, then all the calculations matter. But if your parents gave you a good start in life, and try/ tried to be fair, ignore it. Sibling needs loan. Parents are generous. Someday you'll inherit some money. That's a fantastic thing right there. Maybe in return you get dibs on the family silver or Mom's vintage Porsche.

There has been skullduggery about money in my family, and my feeling is that fairness and generosity between siblings and parents is worth far more than the half the interest on 100K, far more than 100k, even.

The loan should be structured and documented correctly to avoid parents' having to pay gift tax. Whatever works to do that should suffice.
posted by theora55 at 9:29 AM on April 20, 2018 [5 favorites]

Depending on the parents investment vehicle, create a SiblingB account with $100k in it. Effectively, parents have given both siblings $100k today, A chooses to buy a house, and B chooses to invest, and there's no impact on the eventual estate because that money has already been divided.
posted by aimedwander at 9:31 AM on April 20, 2018 [17 favorites]

Nthing what everyone else said, but with a wrinkle. The IRS doesn't like interest free loans between family members, especially open ended ones. Because that's really a gift. So to avoid imputed interest or gift tax complications, you should draft it as a proper loan, with a proper payback period, and with an interest rate at or above the Applicable Federal Rate (AFR) in effect when the loan is made.
posted by AgentRocket at 9:32 AM on April 20, 2018 [6 favorites]

Hm. I guess a lot here depends on family dynamics, but personally I would avoid seeing this as an "advance on inheritance" (which is pretty morbid, especially for parents who are not elderly/ill), and just see it as "this money belongs to the parents, WHO ARE STILL ALIVE, and who can choose to do whatever the hell they want with it. Nothing ever comes out 100% even between siblings, and that is actually totally fine. A few examples from my own life...

--I got more scholarships/grants to pay for college and grad school, so my parents paid more of my sibling's tuition costs
--I was in grad school for a longer amount of time (PhD vs. masters) and my parents ended up paying for my cell phone and flights home during that time, versus my sibling who was working during much of that period

I guess we could try to total up those costs in some complex way, but honestly why would we? It's my parents' money and they get to spend it how they want based on their assessment of their own wants/needs and their kids' wants/needs.

Also, you truly never know what will happen with inheritances. My grandparents thought they would be leaving a very sizable inheritance for their children/grandchildren, but as it has turned out, my grandma has lived MUCH longer than my grandpa (like, by decades) and depending on how medical costs/long term care/end of life care go, she will end up leaving either a smallish inheritance or possibly her kids will end up paying for some of this. Ultimately that money is hers to use as she needs to and it would not have been right for her kids to have been counting on it, even if it seemed to be a large amount at one point in time.
posted by rainbowbrite at 10:27 AM on April 20, 2018 [11 favorites]

Whoever wrote their will should probably be able to spell out a couple of fairly typical options. This kind of thing happens a lot; as suggested above, there are tax and other considerations. And the respective positions of the siblings may change.
posted by BibiRose at 11:19 AM on April 20, 2018

Just noting that you may want to visit a lawyer familiar with the jurisdiction your sister lives in and your parents live in. You never know what may happen in future and future marriage/co-habitation partners may have a legal claim on that $100,000 pre-inheritance if it is not documented correctly. Difficult enough to share money with a loved sibling - worse yet if you have to share it with the ex you never liked in the first place!
posted by saucysault at 11:47 AM on April 20, 2018 [2 favorites]

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