Helping Adult Children With a Down Payment

Dear Carrie,

My husband and I are in our 70s and want to help our daughter with the down payment on her first home. We don't have a lot of cash on hand, but we do have ample savings in our taxable and retirement accounts. What's the best way to proceed?

—A Reader

Dear Reader,

Given today's expensive and competitive real estate market, I'm sure a lot of families are asking themselves this question. In fact, according to a recent realtor.com survey, more than half of first-time home buyers in 2020 had help with the down payment from family and/or friends.

Of course, providing this kind of help is easier said than done because, like you, most people don't have a huge stash of extra cash sitting around. That's why it's important to be strategic in how you handle such a gift—and include it in your larger financial plan.

Let's take a look at some of the considerations to help you decide which option might be best for you.

Conventional wisdom says you should withdraw money from your taxable accounts first, which would allow your retirement funds to stay invested for potential growth. However, the decision ultimately comes down to your age, assets, and individual tax situation:

• If you have ample long-term investments in a taxable brokerage account, you might consider gifting securities outright rather than liquidating the shares and gifting the cash. Doing so would shift any capital gains liability from you to your daughter, who may have a lower tax rate. (Long-term gains are taxed at 0%, 15%, and 20%, depending on income.) If you don't want to pass on any tax burden to your daughter, a taxable withdrawal might still make sense if you have assets you can sell for a loss, which can be used to offset an equal amount of investment gains or up to $3,000 in ordinary income for the year.
• If most of your savings are in tax-deferred retirement accounts, you should weigh whether the withdrawal will bump you into an undesirably higher tax bracket. If you're 72 or older and haven't yet satisfied your annual required minimum distributions (RMDs) from your tax-deferred retirement accounts, you could use all or part of that withdrawal to fund your daughter's down payment, provided you don't need the money for another
• If you have any savings in a Roth IRA or Roth 401(k), consider how gifting from them would affect your tax situation. Withdrawals are tax-free (provided you've held the account for at least five years) and won't add to your taxable income for the year. However, tapping this money will reduce the amount of tax-free income available to you later on.

Of course, the devil is always in the details, so be sure to consult with a financial or tax advisor to think through the best course of action.  

If you find that an outright gift isn't the ideal solution for your financial situation, another option is to lend the money to your daughter. Doing so can provide her with the funding she needs and create a steady flow of income for you from her loan payments.

Just be aware that the IRS requires any loan between family members to be made with a signed written agreement, a fixed repayment schedule, and a minimum interest rate. (The IRS publishes Applicable Federal Rates monthly.) If you fail to charge an adequate interest rate, the IRS could assess gift taxes on the uncollected interest. And if the loan exceeds $10,000, you'll need to report the interest income on your taxes.

Should you ever want to forgive the loan in the future, the unpaid amount will be treated as a gift, and your daughter may owe income taxes on the remaining unpaid interest. The rules around family loans can be complex, so it's best to consult a qualified tax advisor or financial planner before finalizing the details.

If you decide to give rather than lend, the maximum annual gift exclusion—that is, the amount you can give to anyone other than your spouse without having to report the gift to the IRS—in 2022 is $16,000 ($32,000 for a married couple). If your daughter is married, you and your husband could also give her spouse $32,000, for a total gift of $64,000. Even if your gift exceeds this amount, you will not incur gift taxes unless your combined lifetime giving exceeds $12.06 million ($24.12 million for a married couple).

That said, it's essential not to shortchange yourselves in the process. While I applaud your generosity, the last thing you want is to risk becoming dependent on the very people your gift is meant to help.