College expenses are on a lot of people's minds now that interest rates on U.S. government-backed student loans have doubled to 6.8 percent.
One financing option for clients who want to help relatives pay for school but don't want to give a handout is a family loan pool, a trust for dispersing low-interest student loans to their kin.
Financial advisers may be hesitant to employ a strategy that isn't widely used and could stir up family feuds if someone defaults. If properly structured, however, the pool can bring a family closer together.
That's been the experience of George Lewis, a lawyer based in Quincy, Illinois. His family's loan pool, established by his grandmother about 50 years ago, was profiled in The New York Times last fall. After publication, Lewis received about 20 phone calls from people asking for advice on how they could set up a pool of their own.
"We've experienced the extended family really remaining much closer than we could have otherwise," Lewis said.
Rod Zeeb, chief executive of The Heritage Institute, a Portland, Oregon-based organization that trains advisers on multigenerational planning, said he's seeing increasing interest in family loan pools as interest rates on loans and tuition costs rise.
Advisers can use this momentum to educate clients on ways to properly construct intra-family loans.
"Any time you can bring a new idea to a client, even if you don't do the work, you get credit for it," Zeeb said.
SETTING IT UP
Family loan pools are similar to family banks, which typically take the form of a trust or limited liability company. But family loan pools are more narrow in scope, since family banks can sometimes take equity stakes in ventures and make grants as well as loans.
Under a loan pool, a family sets up a trust and bequests an initial sum into it. They then establish rules for how family members qualify for the loans, how long they have to pay them back and what happens if they default.
The family appoints one or more trustees who review the applications to determine who should get the loan. Later in life, those who benefited from the loan pool can contribute.
Tax and legacy planning experts say families should charge interest on the loans equal at least to the so-called applicable federal rate (AFR) approved by the Internal Revenue Service. The rate is currently about 1.2 percent for three- to nine-year loans. Charging interest helps takes care of any tax issues.
A pool could work well for a family that runs a business together, because they're used to separating money and personal issues. It's not a good fit for families who can't respect that wall, and might, say, goad a borrower about missed payments at Thanksgiving.
Families should expect to pay several thousand dollars to set up the trust that will house the loan pool. They can also hire a multigenerational planning expert to address other issues, like what to do about defaults and how to break up the pool if it gets unwieldy after several generations.
"The danger if you do this on the cheap is you could fracture family relationships," said Timothy Belber, a Denver-based adviser to wealthy families on their legacy plans.
Three years ago Belber helped set up a family loan pool for two brothers in Alaska. The brothers put $1 million into the pool and appointed themselves, Belber and an accountant to a committee that reviews the loan applications and makes recommendations to the trustee, who has final approval.
To get a loan, students have to write up a formal proposal about what they want to study and how they plan to pay the money back. Currently three of the eight family members eligible for a loan have taken one.
They are still in school, so repayment hasn't become an issue.
For defaults, the Alaskan family can rely on the shame factor: The trustee sends out a quarterly report detailing the status of the loans. The family also has a process to renegotiate the payment schedule.
Georgia resident and business professor Roy Richards is in the process of setting up a family loan pool in honor of his parents, which will benefit their grandchildren. He's hoping it creates a legacy.
"The idea of having something that keeps us somewhat knit together is a wonderful prospect," Richards said.