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How to avoid family financial sabotage

  • Family "banks" lend relatives their own hard-earned money, rarely charge interest and typically are not repaid the amount loaned.
  • Loans requests from relatives tend to invoke "FOG" — feelings of fear, obligation and guilt.
  • It's important to set financial boundaries and follow IRS rules for gifting.

Did you ever lend or give money to a family member? If so, you're like many who have responded financially to at least one request.

Giving to others can be rewarding, but becoming the family bank or money tree can be stressful, particularly when the amount or frequency of the requests is high. Stress comes from deciding if you can afford the outlay and wondering if the money will be used responsibly. The request can also be packaged in what psychotherapist Dr. Susan Forward called FOG — fear, obligation and guilt. FOG can keep you from saying no when no would be the best response.

If you really think about it, the phrase "family bank" is misleading. Banks use other people's money to make money. Conversely, family members lend their own hard-earned money, rarely charge interest and typically are not repaid the amount loaned.

When you fund a relative whose situation is the result of their bad choices, it's likely he or she will return for another bailout.
Terry Vine/Blend Images | Getty Images
When you fund a relative whose situation is the result of their bad choices, it's likely he or she will return for another bailout.

Deciding not to expect repayment can reduce your anxiety. You still might second-guess your decision, especially if you have to come to terms with forfeiting a needed purchase or valued activity, or even delaying retirement, as you watch the funds vanish.

Requests for financial help from family members can sabotage personal finances and emotional well-being. Being in tune with your situation and the situation of the family member can help guide you in making a decision you can live with. The key is preserving your sanity and encouraging financial stability for both parties involved.

Here are a few tips to keep in mind when a family member asks for financial assistance:

1. Size up the situation: Choices or charity

Is the financial request due to the individual's choices, or is charity necessary because of circumstances beyond their control?

When you fund a person whose situation is the result of their bad choices, it's likely he or she will return for another bailout and get upset if you don't comply. People who make bad choices feed off those who allow FOG to creep in.

These requests are often masked in good intent — such as assistance with car repairs, rent, etc. — only to find that the family member misspent money on pleasure and not necessities. When poor choices are the reason for a person's financial mess, providing financial assistance without addressing the cause is like putting a soiled bandage on an infected wound.

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Charity funding comes into play when the person really needs a break. Life can throw curve balls — a family member could lose a job because of illness or a no-fault car accident, for example. Your investment in their good cause could help the family member find financial stability.

Alternatively, you may need to take on the role of financial caregiver because of medical or physiological conditions. In these situations, several infusions of cash could be required to stabilize circumstances as they arise.

Charity could also represent a wealth transfer to a responsible family member. The funds could be used for a down payment on a home or seed money for a business.

2. Set financial boundaries

Regardless of whether you fund a choice or charity situation, it is important to determine how much and how often you're willing to shell out money and whether you will set up repayment terms. Earmarking how much you will lend or give allows you to say no with assurance.

You can respond without hesitancy that you've reached your limit. This forces the family member to seek other options. In choice cases, it may be just the response needed to turn things around. Charity cases can be more heart-wrenching. Involving other family members and institutions may be necessary for complex situations.

3. Think twice about debt funding

Taking on debt such as a home equity line or cosigning for a loan can turn you into a charity case with no one to rescue you. Debt is a hole that can take years, even decades, to escape.

Cosigning has the seductive feel of only requiring a signature. Unfortunately, the satisfaction that you've helped with minimal effort often turns into being stuck with the payment or taking a credit hit because the family member couldn't or wouldn't repay the loan.

"Honestly evaluate each request, establish boundaries for your own financial self-defense, avoid funding another person's debt and always comply with IRS rules."

With student loans, cosigners typically can't be relieved of the responsibility unless the borrowing family member is credit-worthy. This process could take a long time as you wait for the family member to move up the income ladder and build credit capacity.

4. Comply with Internal Revenue Service gift-tax requirements

For high-net-worth families, gift taxes must be considered when giving funds to a family member. Each year, the IRS sets an amount that an individual can give to another individual that is excluded from gift-tax reporting. You can also pay medical or educational expenses directly without being subject to the gift tax.

Money and assets valued above the annual exclusion and given directly to a family member for a calendar year are subject to the gift tax. You, as the donor, are responsible for reporting and paying the gift tax.

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Loans given to family members must also satisfy IRS rules. The IRS expects you to charge interest for family loans at a minimal rate the IRS sets based on the length of the loan. The interest is considered a gift for gift-tax purposes if the total interest exceeds the annual limit. The amount of interest must also be considered when added to forgiven debt or other gifts when determining if the annual limit has been exceeded for a calendar year.

Helping a family member financially can be a noble action. Protecting yourself from financial sabotage allows you to give from a position of strength, freedom and peace. Avoid the FOG trap; instead, honestly evaluate each request, establish boundaries for your own financial self-defense, avoid funding another person's debt and always comply with IRS rules.

(Editor's Note: This column originally appeared on Investopedia.com.)

— By Lazetta Braxton, founder and CEO of Financial Fountains

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