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Financial Yin and Yang: Coordinating Business And Estate Plans

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It is dangerous to pigeon-hole an affluent client’s financial needs. For example, a prospect referred to you with estate planning needs may be a business owner in need of a business exit plan. Without a clear process to exit the business, it is difficult to design a viable and sustainable estate plan. The exit and estate plans must work together.

Getting answers to following questions will help guide the advisor in creating an exit and estate strategy:

–What is the level of the client’s wealth (affluent, wealthy or rich)?

–When, to whom and how does the client want to transfer the business?

–How much liquidity exists for executing the transfer of the business, including taxes?

Is the client affluent or wealthy?

The level of the client’s wealth affects both the exit plan and the estate plan. If the client is affluent ($1 million-$5 million in net worth), issues concerning retirement income and adequate financial protection may prevail. The business owner is thus concerned with “Do I have enough to continue my life style; what happens if I have unexpected expenses?” If the client is wealthy with a net worth of more than $5 million, the pressing issues may well be more related to wealth transfer and estate taxes. (“How can I pass on my hard-earned wealth without losing it to taxes and costs?”)

One way to determine a business owner’s true wealth is to compare his or her retirement income goal with the likely sale value of the business interest. As an example, I’ll take two business owners with a retirement income goal of $200,000 per year, starting at age 60, who both plan to pay for their retirement primarily through the sale of their respective businesses.

One has a business that will generate a sale of $3 million while the other’s business will sell for $10 million. Although they are both millionaires, the first owner will likely need an exit and estate plan focused primarily on assuring adequate retirement income and sufficient business and insurance protection. In contrast, the business owner with the $10 million sale value is likely to have more than enough retirement capital to maintain the desired $200,000 per year retirement lifestyle. For this owner, how to pass on the excess wealth and avoid transfer taxes is probably a more pressing financial issue.

When, to whom and how to transfer the business?

No estate plan for a business owner will work without a firm understanding of how the business interest will be transferred. The three primary methods via which a business owner can dispose of a business interest are by sale, by capital transfer and/or by gift.

If a business owner is selling the business, the estate plan will stipulate how to deploy the proceeds of the sale, whether at retirement or death. The owner may, however, intend to access the wealth of the business through capital transfers. So though the business may eventually be sold or gifted, the equity of the business interest will be largely transferred out to the owner first.

Examples include creating significant qualified and nonqualified compensation arrangements, establishing consulting or non-compete agreements, and selling through an employee stock ownership plan or ESOP. These strategies may require different estate planning approaches due to the nature of the owner’s retirement income. For example, the owner may be receiving qualified plan and deferred compensation income instead of business installment payments. The nature of the payment will affect the extent and effect of applicable taxes.

Finally, if the business is family-owned and the client is focused on gifting the business, the estate plan is likely to employ discounting techniques, such as grantor retained annuity trusts, intentionally defective grantor trusts and other wealth transfer concepts. Instead of selling the business for its maximum value to a stranger, the owner may want to gift the business at the lowest defensible minimum value to a child.

Knowing the client’s level of wealth and intended mode of business transfer will drive the estate planning techniques to be used.

Is there adequate liquidity?

The techniques described above are moot if there is inadequate liquidity to make the exit and estate plans feasible. What if the intended buyer of the business doesn’t have sufficient capital to purchase the business in the event of a premature death? What if business cash flow is insufficient to pay the owner’s desired level of retirement income?

Even with a wealthy client, liquidity may be a challenge if the source of the wealth is the business interest. Many high net worth, closely held businesses have been financially ruined following the owner’s death. Transfer taxes, debt and poor cash flow can quickly destroy an otherwise viable business.

The well-designed exit plan can help avoid this outcome by creating an appropriate transfer strategy in advance. Funding the nonqualified retirement plan, the buy-sell agreement, or other exit strategy provides the needed capital for payouts. Likewise, the estate plan can use life insurance and other financing techniques to assure wealth is transferred to beneficiaries in the way the owner desires. The exit and estate plan determines the vehicle for the owner’s departure, but the funding provides the fuel.

The financial yin and yang for the prosperous business owner is an exit plan coordinated with an estate plan. Divided, these plans may be ineffective; but integrated and funded, they create a whole greater than the sum of its parts.

Steve Parrish, JD, CLU, ChFC, RHU, is a national advanced solutions consultant at the Principal Financial Group, Des Moines, Iowa. He may be reached at


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