Although interest rates on loans are low these days, the approval process to get the loan can be interesting. Credit card rates are as high as ever and lets not even talk about student loans.
What if your family had it’s own bank that you could go to for a loan? The loan would be granted based on the rules set up by your family, for your family bank and would carry a lower interest rate than the typical commercial loan. The interest and principal you pay goes back into the family bank for use by the next family member needing a loan.
Why set up a family bank?
Want to buy a house? Ask the family bank for the loan. The bank holds the deed until the interest and principal is paid back.
Need to send a kid to college? Ask the family bank for a loan. It may specify that your kid tow the mark on grades or pay a higher rate, but heck, you are getting the best rate around to start.
Need business start up funds? Don’t seek venture capital, get a loan from the family bank. Present your business case to your family bank trustees – who will decide if it is just another hair brained scheme to get money or a real business venture worth funding.
Want to avoid excessive estate taxes? The family bank can help. Because the money is given to the bank, it is not in your estate when you die, lowering the amount that can be taxed.
What is a family bank?
A family bank is simply a fund of money that is given to a trust and/or a limited liability company. The trust or company has rules that specify who can use the money as well as how and when it can be used.
The person giving the money has no control over it after it goes into the trust, the trust or company is the controlling entity. But, the family members are the trustees (or control the trustees).
Who uses family banks?
In the past, wealthy families who wanted to avoid the onerous and excessive taxes involved when money passes from generation to generation were the main users of family banks. Instead of gifting their children and grandchildren, or letting them inherit when the older generation died, they loaned money from a separate fund to them for purposes spelled out ahead of time in the trust or company documents.
If the trust for the family bank is set up correctly, more of the family’s money can go to the next generation instead of being ‘re-distributed’ by the politicians.
Anyone (yes even you) can use a family bank today.
How do you start a family bank?
To start a family bank, you will need to speak with an estate planning lawyer, an accountant and perhaps a financial adviser. That will cost money, so before that, you probably want to gather your family to educate them about what a family bank is and can do. Then your family will want to discuss what rules and procedures to put in place within the trust or business documentation.
For instance, maybe your bank will only loan money to family members who want higher education and it will specify that interest rates will be x percent higher if a grade point average equivalent to a B is not maintained.
Or perhaps, your bank will fund business ventures as well, but says that any family member seeking a loan must present a business case equivalent to what would be given a commercial establishment.
Instructions on what trustees must do if a family member defaults on a loan should also be included.
Report requirements must be established so that any family members funding the bank know what happened to their money.
This is obviously not an exhaustive list and each family will have different desires on what rules to have.
To avoid the most taxes, you can look into establishing a dynasty trust. These types of trusts, in most states, can last up to a set number of years following the death of the youngest beneficiary. So if your 1 year old baby is the youngest beneficiary, the trust can last about 100 years. Some states allow perpetual trusts, you could check into setting up your trust in one of these states.
James E. Huges, in Family Wealth–Keeping It in the Family: How Family Members and Their Advisers Preserve Human, Intellectual, and Financial Assets for Generations suggests the following steps be taken:
- Make sure it is private and not a publicly regulated corporation subject to government laws or SEC regulations.
- Stipulate that it have officers, directors and a board as well as official meeting rules.
- Document the purpose for which the family intends to use the bank. Include the mission of the bank and the family values that mission serves. This will allow everyone, including future generations, to understand why the bank is there.
- Make sure any non-family trustees also understand and agree to the purpose of the family bank.
- Resource: http://www.jamesehughes.com/articles/FamilyBank.pdf
How can you fund a family bank?
So, you don’t have a bunch of excess money laying around, you say. Here are several ways to fund the family bank anyway.
- Family members can gift money to the trust each year – up to the gift tax exclusion amount (currently you can give 13,000 to any number of people each year without paying taxes or reporting the gift).
Typically this might be the older generation, gifting the trust instead of (or in addition to) individual family members.
- The trust for the bank can buy life insurance on the second to die for each generation and branch of the family. The trust pays the premium out of donated funds and owns the policy (which keeps it out of the individual person’s estate). The death benefit is paid back into the trust. Since death benefits are typically much larger than premiums, a significant amount of money can flow into the trust from this strategy.
- Elders in the family can set up their estate documents so that, at their death, the trust is funded from their estate.
What does it cost to set up a family bank?
The cost to set up the bank includes the time your family spends learning about the concept and defining what purpose they want their bank to serve. It includes the cost of hiring lawyers, accountants and financial planners to set up the trust. As a baseline, in the early part of the 21st century it cost us about two grand to set up a family trust.
The trust will also need to be reviewed through the years as tax laws change around it.
Then there is the cost to fund the trust. Family members might donate assets that may rise in value over the years – such as real estate or growth stocks – reducing the gift tax incurred when giving it, but still providing significant assets to the trust. If the trust is funded at the passing of an elder, the cost is to set up the estate plan so that it can occur. If the trust is funded by gifts from current family members, there is an opportunity cost involved for those family members.
Is this something you wish your grandparents had done? Is it something you may consider looking into?
Here are some other resources to peek at if you are interested in exploring a family bank for your family.