This month’s blog post was co-written by Jonah Mayles and Zak Goldman, Partners at Sterling Park.

We often think that creating an estate plan is like a road map: our clients determine what they want the destination to look like (the size, beneficiaries, and goals of the estate). Our role, as one of several advisors to the client, is to help them navigate the journey by considering potential obstacles that can arise preventing our clients from arriving at their desired destination.

A thoughtful and well-executed estate plan is the most important tool to smoothing this path.  And part of that estate plan should provide sufficient liquidity to meet the various needs of the estate.  Many families underestimate the need and cost of creating liquidity for their estate.  We often remind clients that their estates will require liquidity regardless of a significant net worth; particularly if that net worth is comprised of illiquid assets (such as real estate or an operating business). 

The need for liquidity can arise for several reasons, including estate tax liabilities, charitable bequests, and estate equalization. These estate needs are some of the roadblocks and impediments that can prevent a client from achieving their desired estate destination.   

Assessing a client’s net worth is usually a straightforward calculation of assets versus liabilities.  However, determining one’s net worth is a different calculation to determining one’s estate liquidity.  It is important to consider the cost of turning assets into cash for the purpose of funding estate needs.  These costs generally include taxes and professional fees when disposing of assets, taxes on corporate distributions, and the risk of selling assets at an inopportune time. 

The costs associated with liquidating assets are often not the primary concern of the client and their family; rather, it is being forced to sell legacy assets that the family intended on preserving for future generations.  Once these assets are sold, most families are aware that they will never be replaced.  It is important to understand the various options for creating liquidity and the costs associated with each option to avoid the selling of legacy assets.

For example, a client with real estate assets held in various corporations has several options to create liquidity:

1. Disposing of real estate assets – This option will include taxes on the disposition of such assets (often significant when these assets have been for a long time with significant appreciation in value) and dividend taxes on the distribution of capital from the company to the estate (if the capital dividend account balance is insufficient).  Moreover, the family has now disposed of generational assets, and preserving such assets is often a primary objective of an estate and succession plan.  Such assets can provide for multiple generations.  However, this is a good option if the family planned to liquidate the real estate assets in the first place.

2. Leveraging real estate assets – If the family has unleveraged real estate, they can acquire a loan to fund estate needs, using the real estate as security for the loan.  This is a popular initial choice for many families we have met.  Primary considerations for this option are the cost of borrowing and, more importantly, how the debt will eventually be repaid.  The tax debt has been paid but the family will now have to repay the bank debt over a significant period or eventually use option 1 and liquidate real estate.  Borrowing costs would be $4,725,000 if a $10M loan is repaid over a 20-year period ($500K per year) at an interest rate of 4.5%.  That would result in an average cash outflow of $736,250 per year (interest and principal repayment).  This option is kicking the debt can down the road to be dealt with on another day, and such a deferral can be appealing.

3. Cash on hand – This is, of course, the simplest option available.  Unfortunately, it is also the least ‘available’ option to most families.  Many estates lack the available cash and even families that have significant cash reserves, they are often held within corporate structures due to preferable tax treatment.  Accordingly, a family may need $16M – $17M in cash within the corporate structure to net $10M of cash to the estate (assuming a 40% cost of distributing cash from the company).  That being said, families with cash reserves and marketable securities with large inherit capital gains can sometimes, combine the cash and donating of marketable securities to provide for estate taxes.

4. Life Insurance – This option can provide sufficient liquidity at the exact moment its needed.  Of course, health and cash flows need to be considered when considering this option.  In addition, the proper structuring of the insurance product and leverage (if used) is essential to ensure that the estate will be receiving adequate proceeds to fund the estate’s needs.  Client choosing this option rarely need insurance; it is a question of tax-efficiencies and preserving the family’s assets.  The cost of the insurance will vary depending on the age and health of the insured and whether leverage has been used but is generally less than the previous options.  However, clients must be comfortable using current capital for a future need.  Used correctly, a permanent life insurance policy can be an estate-planning solution to provide the estate with the required liquidity needed to deal with end-of-life costs and smooth estate disbursements.  Using life insurance within an estate plan can help bridge these liquidity needs by providing a substantial cash payment within 2-4 weeks that can be used by the estate for its various needs, such as estate taxes and other costs and disbursements.

We believe that when choosing how to fund an estate’s particular needs, all options need to be reviewed and considered.  This is a process that should start with determining one’s goal and intentions for their estate.  Once this has been articulated, a roadmap can be devised to guide the estate to that intended goal.  This roadmap will clarify what can hinder the plan and what is needed to mitigate against potential roadblocks.  The importance of liquidity and its cost and timing is a foundational tool to a successful estate plan.  

DISCLAIMER

Terms of Use

By accessing the Wealth Matters – Our Insights page, you agree that you have read, understood and agree to be bound by the website terms of use, in addition to the terms stated below.  If you do not agree with this website’s terms of use, please exit from this page, and do not access any other pages on this website.

 Cidel Bank & Trust Inc. (including its subsidiaries and affiliates, “Cidel”) reserves the right, at its discretion, to change, modify, add, or remove portions of this page, and the information contained herein, without prior notice. 

 Information Is Not Legal or other Advice

 Wealth Matters – Ours Insights publications are intended to convey general information about legal issues and developments as of the indicated date.  It does not constitute legal, tax, accounting, or any other advice and must not be treated or relied upon as such.

 Statements made in Wealth Matters – Our Insights publications, including the interpretation of case law, are of a general nature only and in no way represent a warranty of the position or accuracy of the law at the time, nor do they pre-determine any position Cidel may take with respect to a specific fact situation or particular client matter. Furthermore, Cidel does not endorse, guarantee the accuracy of, or accept any responsibility for any content written or contributed by third parties who are featured as guest bloggers on Wealth Matters – Our Insights, nor does Cidel endorse, guarantee the accuracy of, or accept any responsibility for the content of third-party websites or materials that may be linked, quoted or otherwise referenced in these publications.  For greater certainty, Cidel does not warrant or guarantee that the information contained on this page is accurate, complete, updated regularly and obtained from reliable sources.

 In making the Wealth Matters – Our Insights page available, no client, advisory, fiduciary or professional relationship, including a client-solicitor relationship is created, intended or established. The contents are not a substitute for the user seeking advice from a professional that is familiar with the reader’s factual situation or circumstances.