Understanding Intra-Family Loans: A Smart Way to Give (and Grow)

When thinking about your family’s financial future, you may want to support the next generation while being intentional about transferring wealth. While gifting is a familiar approach, another highly effective, yet often overlooked, strategy is the intra-family loan. When structured correctly, it can deliver significant benefits for both lender and borrower, while keeping wealth in the family. It's important to understand how intra-family loans work.

What Is an Intra-Family Loan?

An intra-family loan is a formal, documented loan from one family member to another. Like any legitimate loan, it must include:

• A written loan agreement

• A repayment schedule

• An interest rate

These formalities aren’t just good practice - they’re essential. Without them, the IRS could reclassify the arrangement as a gift, potentially triggering unwanted gift tax consequences.

The interest rate must be at least the Applicable Federal Rate (AFR), set monthly by the IRS. The AFR is usually far lower than commercial lending rates, creating an opportunity for meaningful financial leverage.

Key Benefits to Intra-Family Loans

1. Tax-Efficient Wealth Transfer If the borrower earns a return on the borrowed funds that exceeds the AFR, the excess "spread" effectively transfers to them free of gift tax.
   

2. Keeps Money in the Family Instead of paying interest to a bank, interest payments go back to the lending family member, providing a steady income stream.
   

3. Flexible Terms The loan can be tailored to fit your family’s needs, such as interest-only payments with a balloon at maturity, or a fully amortizing schedule.
   

4. Encourages Financial Responsibility Unlike an outright gift, the repayment obligation can help instill financial discipline and accountability.

Common Uses

Intra-family loans can serve many purposes, including:

• Helping a child purchase a home at a lower-than-market rate

• Providing startup or investment capital for a business

• Paying off high-interest debt

• Funding a family trust for investment growth

• Purchase private placement life insurance

How It Works: In the intra-family loan example, the borrower earns 7% on the invested funds but only pays 4% interest back to the lender. The 3% "spread" is the tax-free wealth transfer, without using any gift tax exemption.

Important Considerations

While powerful, this strategy comes with both financial and relational risks.

IRS Compliance:The loan must be properly documented, with payments made and recorded. Failure to follow formalities could result in the IRS treating it as a gift.

Family Dynamics: Lending money can be emotionally charged. Clear communication and agreed-upon expectations are critical.

Financial Risk: The lender should only extend funds they can afford to part with, regardless of the borrower’s investment results.

An intra-family loan can be a smart, strategic way to support loved ones and meet estate planning goals. But success depends on proper structuring. Work closely with your attorney, tax advisor, and financial planner to ensure your loan is designed to protect your wealth, and your family relationships. Let's connect if you have interest in evaluating how to leverage intra-family loans with private placement life insurance (PPLI).

This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and are provided with the understanding that neither TRC Financial, nor M Financial are engaged in rendering tax, legal, or actuarial services. If tax, legal, or actuarial advice is required, you should consult your accountant, attorney, or actuary. Neither TRC Financial, nor M Financial should replace those advisors.