Published June 21, 2013
Dear Let's Talk Credit,
My niece is overwhelmed with credit card debt and student loans. She finally has a full-time, good-paying job. I want to help her consolidate her credit card debt. Should I transfer it to a 0 percent card and have her make payments to me? I also want to try to negotiate two collections she has, by having them take a lump sum for a lower amount than is due, as opposed to her making monthly payments. How will this affect her taxwise? Lastly, she is putting $80 a month into her 401(k) account. Should I have her stop that for awhile in order to pay down some of this debt? My thought is that she is young (25 years old) and has good earning potential in the future. Thank you for any help you can give me.
Your niece is lucky to have such a money-savvy aunt! Your idea of consolidating her credit card debt onto one 0 percent interest rate card is a great way to save money on interest payments and to help her pay off the debt more quickly.
However, if your plan is to acquire a card with a 0 percent introductory rate in your name and then transfer your niece's debt onto it, you will effectively be taking responsibility for her debt. Regardless of your niece's ability to pay each month, you would be responsible for making the payments because the credit card would be in your name. Before you move forward, have an honest conversation with your niece about the risk you would be taking on her behalf. You also need to ask yourself if you have the funds to assume the payments if your niece cannot.
Because your niece has a couple of collection accounts, it is unlikely that she would qualify for a 0 percent credit card in her name only. But, as time passes and her credit improves, you might consider transferring the debt onto a card in your niece's name when and if she qualifies for a 0 percent or low interest rate card.
Your idea to settle the collection accounts with a lump sum payment for less than the full balance owed will save money and stop the collection process. It will also reflect negatively on her credit report. Again, if you will be the one making the lump sum payment and then receiving payments from your niece, be sure you can afford to be that generous if she is unable to pay you back.
Your niece would have tax consequences for any forgiven debt. The U.S. tax laws classify forgiven or canceled debt as income. Creditors and debt collectors that agree to accept at least $600 less than the original balance are required by law to file 1099-C forms with the Internal Revenue Service. For example, if you settle a collection account for half the amount of $1,500, the $750 forgiven amount would be reported to the IRS as income. Your niece would receive a 1099-C tax form and the amount forgiven would be added to her income for that tax year.
I recommend that your niece continue to make her 401(k) contributions, particularly if her employer is matching her funds. It is true that she is young and should have many more years to contribute, but it is also true that money that she invests in her 20s will grow a great deal more before retirement age than money invested in her 40s. If your niece doesn't already have a detailed budget and spending plan, I suggest that she develop one. With a plan in place, she will know what it will take to pay off her debt and accomplish her other financial goals.
Let's keep talking!
See related: Bailing family members out of debt? Think twice