(MONEY Magazine) – If you are helping your parents with their medical care or such everyday chores as shopping and housekeeping, chances are you regularly give them some financial support as well. Or if you don't do so now, you eventually will. In a study this year of 4,700 employees, Advanced Research Management Consultants found that more than three-quarters of those who provide personal care for an elderly relative or friend also assume some degree of financial responsibility for that person -- with more than a third of them spending $2,500 or more a year. Even if your parents' financial needs are modest now, you can't count on their staying that way. Inflation -- even today's relatively benign strain -- can quickly erode a retiree's purchasing power. Assuming that the cost of living continues to rise at the current 5.5% annual rate, for example, the real value of a 65-year-old's fixed income would be halved by the time he or she turns 80. And as your parents' physical dependency increases, requiring ever-greater outlays of cash for medical care and related services, their financial dependency will likely rise in tandem. The pattern is all too familiar to Frank Raczka, 51, a Chicago postal worker who opened his home to his 91-year-old mother after she suffered a stroke two years ago. Last January, his mother had a second, more debilitating stroke, prompting Frank and his three brothers to move her to a nearby nursing home. The monthly fees of around $1,700 for the intermediate care she now receives as an ambulatory patient are covered by income from her pension and investments. But the brothers worry that a third stroke could leave her bedridden and double the cost of her care. ''When her savings are gone, I don't know exactly what we will do,'' Raczka concedes. ''But we will find a way.'' Most adult children do indeed find a way in such situations. The challenge is to find the best way -- a solution that helps your parents meet their expenses without either diminishing their self-respect or depriving your own family of needed resources. Compromises are inevitable. Before offering your assistance, do think through what you can reasonably give. Are you prepared to step in, if necessary, with cash out of your own pocket? Can you afford to do so without jeopardizing your own long-term goals, such as building a college fund for your children or saving for your own retirement? The sooner you sit down with your parents to discuss their needs, the more likely it is that you will be able to avoid the most painful choices.

STRETCHING AVAILABLE DOLLARS Your first step should be to analyze all of your parents' assets to ensure that every dollar is pulling maximum weight. If they are counting on income from their savings and investments to see them through their retirement, review their portfolio to make sure it's adequately diversified and, yes, appropriately aggressive. ''While younger investors are usually motivated by greed, older ones are motivated by fear,'' says Danbury, Conn. retirement consultant Robert Preston, who notes that this quest for security typically leads retirees to keep the bulk of their assets in passbook savings accounts, certificates of deposit and Treasuries. While undeniably safe, such low- yielding investments can rob your parents of much-needed extra income while increasing the chance that their financial independence will be ultimately undermined by inflation. To redress these portfolio imbalances, Preston recommends that you encourage $ your parents to keep between 40% and 50% of their assets in long-term growth investments, such as blue-chip stocks or equity mutual funds. At the very least, he says, try to convince your parents to switch savings out of the 5.5% passbook account they've held for years and into an almost equally safe but higher-yielding money-market mutual fund (see page 76). If your parents are already in a cash crunch, look at ways to wrest additional income from their less liquid assets. If your parents have a whole life or universal life policy, for example, they might take out a loan against its cash value. A widowed parent, who no longer has to protect a surviving spouse, might simply surrender the policy and invest the proceeds for steady income. Your parents' most valuable weapon in the struggle to stay solvent is likely to be the family homestead. Roughly 75% of Americans age 65 or older own their own homes. Yet according to the Department of Housing and Urban Development, some 2.9 million of them have annual incomes of less than $15,000. If your house-rich but cash-poor parents are willing to move, trading down to a smaller place is probably the smartest strategy. As long as one of your parents is 55 or older and they have lived in the house for at least three of the past five years, they are entitled to a one-time exclusion that exempts from taxes as much as $125,000 of their capital gain from the sale of their home. They can then use part of their profits to buy or rent a smaller place with lower property taxes and maintenance costs and reinvest the rest in an income-producing asset. In addition to the financial benefits, your parents may find a smaller home more manageable for their retirement years. Frank and Dolores Tenerovich provide a happy case in point. The couple were just getting by on their $20,000-a-year retirement income when their daughter Judi Jaskiel, 33, suggested that they sell their home and move closer to her. As a convincer, she and her husband Jeff remodeled a two-bedroom guesthouse on their eight-acre spread in Mentor, Ohio, east of Cleveland. So last year, Frank, 72, and Dolores, 69, unloaded their home a few miles west, took their one-time $125,000 capital-gains exclusion and moved in. They pay a nominal rent of $350 a month and invested the proceeds from the sale in CDs to provide them with extra income. Your parents, however, may be understandably reluctant to leave the home they have occupied for many years. If the place appeals to you as an investment or for sentimental reasons, you might consider buying the house yourself and leasing it back to your parents. This transaction converts the property into a source of income for them and gives you the tax benefits of a rental real estate investment and potential appreciation. In a twist on this arrangement, Mike Wegener, 40, of Beaverton, Ore. recently bought the $40,000 three-bedroom ranch house in Portland owned by his father Carl, 71, who suffers from Alzheimer's disease. Mike's $350 monthly installment payments help pay his dad's expenses at the residential home where Carl now lives. If you have neither the money nor the inclination to buy your parents' home -- and they cannot find another investor to enter into a sale-leaseback agreement -- a reverse mortgage could be the answer. These loans typically pay the homeowner a fixed monthly sum, while deferring repayment of principal and interest until the house is sold. Pending legislation could make such deals, which until this year were offered by only a handful of private lenders, more widely available. Under a pilot program launched in July, the Department of Housing and Urban Development agreed to insure 2,500 reverse mortgages written for people 62 or older. Since then, the agency has received more than 20,000 inquiries, and Congressmen James Florio and Frank Pallone Jr. have sponsored a bill that would expand the number of reverse-mortgage loans to 25,000. HUD Secretary Jack Kemp has not taken a position on the bill, which is in a House subcommittee. But he has officially endorsed the increase. Although specific provisions vary widely, there are three major types of reverse mortgages. Line-of-credit contracts let the borrower make withdrawals against his or her home equity as needed -- rather like a home-equity loan but without the need for immediate repayment. Such loans are best suited to those whose income meets their current living expenses but who would be strapped for cash in an emergency. Term reverse mortgages provide high monthly income for a fixed period, often five to 10 years. They are appropriate for those who plan to move at the end of the term -- say, for a parent now on the waiting list for a retirement community or nursing home. Tenure reverse mortgages provide income for as long as the owner lives in the home, but payments are smaller, of course, than under a term loan. In all these cases, the homeowner gets a higher payout with lower interest charges if, when the house is sold, the ^ lender gets a percentage of the house's appreciation during the period of the loan.

HELPING FROM YOUR OWN POCKET Even with the canniest management of your parents' resources, the time may come when they need direct financial assistance. If your parents still have some assets of their own, one of the best ways to boost their income is the so-called split-interest purchase. Under this joint-purchase arrangement, you and your parents divide the cost of an investment (often an income-producing asset like a bond) and agree that they get all of the income while they live and that you receive the assets and any capital gains after they die. One caveat: the Internal Revenue Service is carefully scrutinizing the estate-tax treatment of split-interest purchases. If your parent has assets worth more than $600,000, check with a tax specialist before pursuing this strategy. Albert S. Barr III, an estate-planning attorney in Baltimore, offers this example of asset splitting in action: a widow and her daughter decide to pool their funds to buy $50,000 worth of Treasury bonds, recently yielding around 8%. They draw up a contract stipulating that the mother will get all the income from the securities during her lifetime. When she dies, ownership of the bonds will go directly to her daughter, bypassing probate. The initial purchase allocation for each of them is determined by a complicated IRS formula, based in part on the mother's life expectancy. In this case, the 70- year-old widow must contribute about $32,000 to get the income from $50,000 worth of bonds. Her yield: 12.5%. When your parents don't have the money for such an investment, you and any of your siblings who can afford to do so may simply give them the money they need directly. By law, you can make a gift of as much as $10,000 a year to any individual ($20,000 a year if you give the gift jointly with your spouse) without incurring any gift tax. If your parent's taxable income is less than $2,000 a year and you provide more than half of his or her support, you can get a $2,000 exemption by claiming your parent as a dependent. When you and other siblings together provide more than half of your parent's support, any one of you (but only one) who supplies more than 10% of the total can claim the exemption -- as long as none of you pay more than 50%.

You may also be able to write off at least some of the medical expenses you pay on your parents' behalf if you provide more than half of your parents' | support. As with all medical write-offs, however, these expenses are deductible only to the extent that they, together with the out-of-pocket medical costs for the rest of your family, exceed 7.5% of your taxable income. Whether you give the money directly or indirectly, cash gifts to your parents may create some unwelcome emotional complications -- especially if there are several siblings in your family in widely differing financial brackets. Giving your parents a loan instead can help smooth the difficulties. Suppose, for example, that a parent has exhausted most of his or her financial assets and has little more than the house and furniture remaining. The child who writes the check each month tends to wonder ''why isn't Harry helping'' to keep Mom afloat. After her death, the check writer may feel understandably resentful if Mom's will divides the heirloom silver equally between him and Harry. But if the transaction is a loan, the money can be repaid tax-free from the estate, probably when the house is sold, suggests Baltimore financial planner Jay Perry. If you cannot afford either to give or to lend your parents the money they need to live independently, you may choose to take them into your own home, thereby saving them the expense of room and board. Of course, the decision to have your aging parent move in involves far more than financial considerations, as discussed on page 148. Should you and your parents decide to merge households, you may be eligible for a helping hand from the government. Under the dependent-care tax credit, if your elderly parent lives with you and you have to hire someone to look after him or her while you work, you can get a credit of up to $720 to offset as much as $2,400 in expenses. More than half the states also offer similar dependent-care tax breaks on your state return; your local agency for the aging will know whether your state is among them. In addition, roughly 20% of employers now offer a dependent-care spending account that permits you to pay with pretax dollars as much as $5,000 of your annual expenses for the care of a parent who lives with you. But you cannot both claim the tax credit and seek reimbursement from a flexible-spending account for the same expenses. If you are in the 15% federal bracket and your expenses do not exceed the $2,400 limit for a tax credit, you are generally better off taking the credit; otherwise, the flexible-spending account generates a bigger tax break.

TAPPING OTHER FINANCIAL RESOURCES If one or both of your parents become completely incapacitated, the cost of their care may well be beyond your family's ability to cope. In that case, your only alternative may be to help your disabled parent apply for Medicaid, the federal and state medical welfare program. The criteria for qualifying are stringent: a disabled applicant who is married cannot hold more than about $2,000 in assets. The healthy spouse is allowed to keep only $12,000 to $60,000 of their total joint assets (the amount varies by state), not counting the house. But your parents may be able to preserve more than these amounts, as Cleveland attorney Armond Budish explains in his new book, Avoiding the Medicaid Trap (Henry Holt, $22.50). A common strategy is to transfer assets into an irrevocable living trust, which (if properly set up) shields them from Medicaid, even though the nondisabled parent may receive income from them. The disadvantage is that the incapacitated parent cannot receive Medicaid for as long as 30 months after making any transfer. One word of warning: it is crucial to have such a trust set up by an attorney who is familiar with the intricacies of Medicaid law. (For a free referral to specialists in your area, send a stamped, self-addressed business- size envelope to the National Academy of Elder Law Attorneys, 1730 E. River Rd., Suite 107, Tucson, Ariz. 85718.) A badly drawn trust can beggar the family, as Budish has seen in his legal practice. ''A lot of lawyers don't know the basics in this area,'' he says. ''But there are perfectly legal techniques for older people to protect assets -- and I agree with the late Congressman Claude Pepper that it is not only ethical but crucial for them to do so.''