We recently came across a situation where a family was forced to sell a very large piece of real estate that had been in the family for several generations. When the family farm was transferred during the inheritance, estate taxes were due. The problem was there was no liquidity in the estate, nor did the heirs have the means to pay the taxes due. To generate the liquidity, the family was left with few options and had to sell the farm to generate the cash. This was a bit of a blow to the family legacy.
The family sold the farm, and while the sale price generated much more than the tax bill, the three-generation legacy was lost. Not everyone is in this situation; however, liquidity in an estate is an essential part of your financial planning. This was a very large estate, and this occurred prior to the Tax Cuts and Jobs Act, which nearly doubled the estate tax exclusion. Now that the estate tax exclusion is $11.21 million per person, or $22.42 million per couple with portability, estate taxes are not likely to cause most estates a problem.
However, there are other immediate expenses you may need to plan for, including final hospital or doctors’ bills, funeral expenses, executor or administrators’ fees, attorney’s fees, appraiser’s fees, and probate court costs, to name a few. While your estate may not include a three-generation family farm, it could consist of a large family home or vacation home, a small business, collectible art or antiques, or a car collection. These are some common examples of illiquid property, or property that cannot easily be turned to cash. Only a specialized buyer will pay what these items are worth. If you’re forced to sell to generate cash, you may end up selling them for far less than they are worth.
Unsurprisingly, planning while you are alive is preferable. A simple life insurance policy can provide nearly immediate cash after a death. Through planning with your financial adviser, you should be able to estimate the liquidity needs of your estate. You should then be able to purchase a policy to ensure cash is available precisely when it is needed most. Your adviser can also help you decide which settlement option is right for your situation, and if the beneficiaries of the policy should be your heirs or your estate. You should also consult a tax adviser as proceeds could be includable in your gross estate.
Small-business owners can also benefit from life insurance policies when they are used to fund a buy-sell agreement with business partners. Should one of the partners pass away, the life insurance policy could provide the remaining partners sufficient funding to pay out the deceased partner’s heirs.
Other options you may consider include borrowing against your own assets or the estate; however, borrowing only postpones the liquidity problem if you are trying to keep illiquid assets in the family for sentimental reasons. Your heirs may be able to use any undistributed retirement benefits you have, but these will likely be subject to distribution requirements and income taxes. Survivor annuities may also provide some liquidity to pay expenses. You can also plan to leave enough cash and/or securities as part of the estate to cover any immediate liquidity needs.
As part of your financial planning process, providing liquidity for your estate should be addressed, especially if you have illiquid assets you intend to pass on to your heirs. If you have questions regarding your estate’s liquidity needs, the experts at Henssler Financial will be glad to help: