What Is Estate Liquidity?
In general, property is either liquid or nonliquid (also known as illiquid). Typically, liquid assets consist of cash and other assets, such as securities, that can be quickly converted into currency. Liquidity of an estate refers to its ability to pay taxes and other expenses incurred after mortality using cash and cash alternatives. If the majority of your assets are illiquid (such as real estate or business interests), your estate may be forced to sell assets in order to meet its obligations as they mature. This may result in a financial loss or force your family to liquidate assets you intend for them to retain. Consequently, liquidity planning should be one of your primary estate planning objectives.
Why the Need for Estate Liquidity?
Many of our Fortune 500 customers were shocked to discover that the cost of dying can be quite high. The majority of these expenses are unavoidable and must be paid promptly; for example, estate taxes are typically due within nine months of the decedent's passing. In fact, liquidity may be the most pressing need for your estate. Therefore, it is essential that these Fortune 500 employees remember that sufficient liquidity, or its absence, may determine whether your requests are carried out. Here is a list of potential expenses for which you may need to budget:
-
Medical bills from your last illness
-
Expenses for funeral, cemetery monument, and burial site
-
Executor or administrator's expenses
-
Lawyer's costs
-
Appraisal costs
-
Probate court expenditures
-
Debts
-
Death and taxes on earnings
In addition to these costs, Fortune 500 clients should consider their family's ongoing living expenses and any other special requirements, such as funds for their children's education or caring for a handicapped child.
What Are Your Available Options for Estate Liquidity?
Distribute Assets Other Than Cash
The cash in your CDs, savings accounts, and checking accounts is a source of immediate liquidity. Save this cash for estate obligations by distributing specific nonliquid assets in lieu of liquid assets to your beneficiaries in your will; for example, John receives the automobiles and boat, while Jill receives the residence.
Caution: Do not rely on the cash you ordinarily have on hand to satisfy all the liquidity needs of your estate. In practice, you would need to accumulate these cash reserves to a level that makes no economic sense. Also, you may want to ensure that your executor has easy access to these funds.
Borrow
The executor or administrator of your estate may sometimes encumber (borrow against) the estate's assets. In practice, however, this is not a viable option and should not be relied upon to meet your estate's liquidity requirements. Generally, probate laws prohibit an executor from procuring a loan without incurring personal liability for the debt, unless your will expressly authorizes this. This restricts the availability of credit, even if your executor agrees to assume such a duty. Furthermore, we would like to remind these Fortune 500 employees that borrowing only delays the issue. The loan will ultimately have to be repaid with interest.
Sell Estate Assets
Although your goal is to avoid forced liquidation, it may be desirable to sell some assets in order to meet the estate's liquidity requirements. You may own assets that no one else desires, such as an antique utensil collection or a hunting lodge in Maine. The sale of such assets provides liquidity to your estate and relieves the burden of receiving them from your beneficiaries. These Fortune 500 employees must grant their executor permission to sell their property.
Redeem Stock
In accordance with a Section 303 stock redemption provision, a corporation may distribute cash to a stockholder to cover estate expenses and taxes. In accordance with this IRS provision, your estate is not subject to ordinary income taxes on the entirety of the distribution, as it would be for dividend distributions. The redemption is instead regarded as a capital transaction. This may result in substantial tax savings for the corporation, providing liquidity for your estate. To qualify for this tax treatment, a number of eligibility and other conditions must be met.
Undertake a Buy-Sell Agreement
A buy-sell agreement is a legal contract that is typically used by the proprietor of a closely held business to transfer his or her interest to the business's successors. It is a contract that you can engage into now to facilitate the sale of your business interest to family members or other parties in the future. Under the provisions of a buy-sell agreement, the buyer is legally required to purchase your business interest from your estate, and your estate is legally required to sell your business interest upon your passing. One of the numerous benefits of a buy-sell agreement is that it provides the cash necessary to pay estate taxes and administration costs. There are numerous varieties of buy-sell contracts. Numerous considerations must be made when determining which option may be optimal for you.
Purchase a Survivor Annuity
Certain annuities terminate upon demise. However, there are annuities known as joint and survivor annuities that persist until the death of a second individual. A joint and survivor annuity provides an annuity for the participant's life as well as a survivor annuity for the survivor's life (e.g., a spouse or companion). Joint and survivor annuities can be either refund annuities that pay a single sum at death or period-certain annuities that pay only in installments.
In either case, naming your estate or executor as the beneficiary of a survivor annuity can provide your estate with liquidity to pay for expenses incurred by your estate. You may designate a family member as a beneficiary for any Fortune 500 employee whose solitary intention is to provide for their family. Be aware that, for estate tax purposes, the total value of the remaining payments will be included in your gross estate if they are made to your estate.
Take Retirement Benefits
If you do not receive all of the retirement benefits you are entitled to from your retirement plan prior to your death, they will be distributed to your estate or a beneficiary until they are all paid out. Consequently, retirement benefits can also be a source of liquidity, though typically not directly to your estate.
Caution: We would like to remind our Fortune 500 clients to exercise caution when naming a non-spouse beneficiary. Some state laws mandate that estate taxes owed on the portion of the estate attributable to the retirement benefits must be paid from the retirement benefits, depriving the beneficiary of those funds. You can avoid this outcome by directing in your will that certain assets, such as the residual estate, be used to pay estate taxes. You should also bear in mind that when they are distributed from the plan, the majority of retirement benefits will be subject to income tax, which will reduce their net value.
Buy Life Insurance
Life insurance is the most common method of providing liquidity. The contract for life insurance, also known as liquidity insurance, is made with a commercial provider. You agree to make installment payments to the provider, and the provider agrees to pay a specified portion of the proceeds to a designated beneficiary upon your passing. For many, life insurance provides funding for an estate that would not exist otherwise.
If you have accurately anticipated the liquidity requirements of your estate, the necessary funds will be available exactly when they are required. When purchasing life insurance, Fortune 500 employees should consider how much coverage they require, the type of policy that best suits them, and who their beneficiaries should be. You must also choose a disposition option, such as whether the proceeds will be distributed directly to the beneficiary or to a trust. You should also be aware that purchasing life insurance has tax implications.
Despite the fact that this is a highly technical field, here are some general guidelines:
-
For estate tax purposes, proceeds payable to your estate, your executor, or an individual or trust legally obligated to pay estate debts are included in your total estate.
-
For estate tax purposes, the proceeds payable to anyone on a policy in which you retain any cash value at the time of your death or within three years of your death are included in your gross estate.
-
If you own a policy on the life of another person and die before the insured, the cash value of the policy is taxable as part of your gross estate.
-
Except for transfers for value and gain on the surrender of a policy, proceeds are typically exempt from income tax.
Technical Note: "Incidents of ownership" is a legal term that, in general, refers to any right to control or economically benefit from the policy (e.g., the ability to designate a beneficiary, surrender the policy, or borrow against its cash value).
Defer Payment of Estate Taxes
If unable to make estate tax payments when they are due, your personal representative may (1) request an extension of time to pay or (2) elect to pay a portion of the tax in 10 or fewer annual installments if the estate consists primarily of an interest in a closely held business.
Research indicates that one way to provide for estate liquidity is by utilizing a life settlement, which involves selling a life insurance policy to a third party for a lump sum payment. A study conducted by the London Business School suggests that life settlements can be a viable option for individuals who no longer need or can afford their life insurance policies. By selling the policy, retirees can generate immediate cash to address estate liquidity needs and eliminate ongoing premium payments. This option can be particularly beneficial for individuals with life insurance policies that have accumulated substantial cash values. (Source: "The Secondary Market for Life Insurance Policies: Estimating the Value of Life Settlements," London Business School, 2021)
Providing for estate liquidity can be compared to constructing a solid bridge that ensures a smooth financial transition for your loved ones. Imagine you are an experienced engineer tasked with building a bridge that connects two thriving cities. This bridge serves as a vital link for the flow of goods and resources between the communities. Similarly, in estate planning, ensuring liquidity acts as a bridge that connects your assets to the financial needs of your beneficiaries. Just as a well-constructed bridge allows for seamless transportation, proper estate liquidity planning enables the efficient transfer of funds to cover expenses like estate taxes, debts, and ongoing living costs. By carefully constructing this financial bridge, you guarantee a secure passage for your loved ones, safeguarding their financial well-being and providing them with the resources necessary to thrive even after you're gone.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that focuses on transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.
The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.
