The "estate" of most individuals is worth more than just money. A family business, a summer cabin on the lake or an antique car collection may be part of a legacy, rich with family history, that your client wants to pass on to his or her children and grandchildren. The challenge is to develop a plan that satisfies your client's desire to pass along specific assets to certain individuals, while making sure each family beneficiary is treated fairly and equitably.
Individuals are often unaware of what the potential planning needs are and may not see the hidden stresses involving distribution of family assets, both tangible and intangible. These assets may not be easily dividable, may have fluctuating values and lack liquidity, as well as potential tax liabilities. The goal of an estate plan that involves estate equalization is to balance the desires of the parent(s) making bequests to certain individuals and the desire to maintain an equitable value to each heir.
The first step is to help your client decide how he or she wants the estate to be distributed. This takes careful planning and open discussion with family members and other advisors, such as an accountant, lawyer, real estate advisor, business valuation expert and possibly an expert in collectibles valuation. Each asset should be carefully considered with respect to its value (monetary as well as emotional) and the plan developed from there.
Consider a hypothetical client, Ellen, who is not married, and has two grown children. Ellen runs her own business with her son Jim, who is heavily involved in the business, and is prepared and willing to assume the role of owner upon Ellen's death. Ellen's daughter, Lilly, is a successful professional living in another state. Even if she moves back, Lilly has no experience with the business and does not anticipate being involved in its day-to-day operation.
Ellen's estate is worth about $2.2 million: the business is valued at $1.5 million; and the remaining assets include Ellen's home, her savings and some original art work that was recently appraised for $150,000. Ellen and Lilly share the same love for the art, and Ellen intends to pass the full art collection to Lilly.
If Ellen were to leave her business to both children, Jim may be forced to sell valuable assets in the business or to use business cash flow to compensate Lilly, which could compromise the business itself. Since Ellen does not know if she will use the value of her home and savings to provide for her retirement income, and possibly long term care expenses, leaving Lilly the remainder of the estate (including the art collection) after leaving the business to Jim does not seem fair.
Estate equalization with life insurance
A life insurance policy on Ellen's life, naming Lilly as the beneficiary, can help ensure an equitable distribution of assets. By purchasing a life insurance policy for Lilly on her own life, Ellen will make certain that her children inherit nearly equal shares of her estate. The life insurance proceeds, along with any other remaining assets, provide an inheritance for Lilly and the full business interest is transferred to Jim.
While there are several possible scenarios for purchasing the life insurance that involve gifting and certain trust arrangements to keep the death benefit from being included in Ellen's estate for estate tax purposes, ultimately, the life insurance proceeds will give Lilly cash, equivalent to a portion of the business value, instead of a share in the business. While the amounts do not come out exactly equal, it is equitable and both children have been treated fairly.
We often think of using estate equalization techniques when a business owner has several children or heirs with differing involvement in the business. However, the same techniques can work when there is no business interest, but "differing interests" is still the key factor.
Case study 2
Let's look at another example. John and Sue sold their restaurant several years ago and used some of the proceeds to purchase a vacation home on the beach. Since then, the beach home has been the vacation/weekend spot for the whole family, which now includes grandchildren. Sue has also written two popular cookbooks on which she receives royalties. Other assets include a rental property and a stock portfolio. Of the couples' three children, two live close to the beach house and, along with their families, are frequent visitors. The third child recently relocated to a distant state and does not have any long term interest in the beach house.
John and Sue would like to leave their estate in equal amounts to their children but see potential problems. Leaving all three children an equal interest in the beach house could cause difficulty if the third child is not interested in owning real estate that she will never be able to use; she would prefer to receive her interest in cash. Even if her inheritance consisted of the remaining estate, the value of these assets may fluctuate significantly over time, possibly resulting in unequal distributions to the three children.
This is a case where life insurance, probably a joint life contract on John and Sue, along with a trust, can help provide equitable distribution of assets at death. A trust is a flexible instrument for wealth transfer, allowing John and Sue to provide detailed instructions for the distribution of their assets, enabling them to use the value of estate assets, the beach house, and the life insurance proceeds so that all three children are treated fairly and equitably.
Dorothy Vautier CLU, ChFC, is an advanced sales consultant at National Life Insurance Co., a unit of National Life Group, Montpelier, Vt. You may e-mail her at email@example.com