The Need for an Estate Liquidity Review. Estate Liquidity Review Producer Guide. For agent use only. Not for public distribution.

Transcription

1 The Need for an Estate Liquidity Review Estate Liquidity Review Producer Guide

2 Estate Liquidity Review The Need for an Estate Liquidity Review Death triggers a long list of costs that must be paid from a client s estate. These costs include: Funeral, medical and burial expenses Payment of debts Estate valuation and probate court costs Legal and accounting fees Executor/Administrator expenses Federal estate and state death taxes If an estate lacks sufficient cash to meet its obligations, an executor typically has two means to raise the needed funds: sell capital assets or borrow. Selling Capital Assets The executor will rarely find the sale of a capital asset a quick or easy matter. Done in haste to meet obligations currently due, the executor will likely have to forfeit some value for the convenience of a speedy sale. In other words, the cash received for a forced sale will usually be significantly less than the true value of the asset, and the estate and heirs will simply lose the difference. This loss of value is particularly true when the capital assets consist of business interests, farms, real estate or other unique and illiquid assets. Borrowing The executor may preserve the capital assets and still satisfy the estate s cash obligations by borrowing whatever funds are needed. However, all of the problems normally associated with a loan and more will probably apply here: The executor must find a lender willing to make a loan of sufficient size, for an appropriate duration and at a reasonable rate, The executor must keep the estate open until this new obligation is satisfied, thus potentially subjecting the estate to additional costs and delays in distributing assets to heirs, and Another source of liquidity must be found to pay off the loan principal and interest. Solving this last problem may still involve the selling of capital assets, although the executor may have a better chance to realize something closer to full value on the sale. Still, if the heirs valued the asset either for its growth potential or for sentimental reasons, its loss could represent a bitter pill to swallow. Their alternative will likely be to pay the debt service themselves. 1

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4 Estate Liquidity Planning and Life Insurance: A Solution. Any solution to the liquidity problem will have a cost. The questions include: How much cost? When does it get paid? Who pays it? Saddling the executor with selling capital assets or financing estate obligations postpones the problem until after the death of the owner. However, ultimately the cost for this postponement is paid out of what otherwise would have been an inheritance. This cost involves possible loss of the asset, possible loss of value if the sale of the asset is forced, possible debt service passed on to the heirs, not to mention the increased cost to the estate of carrying out either of these strategies. The best solution to this dilemma may be the use of life insurance. Using life insurance as a solution brings the cost forward into the present. The cost of this solution (the life insurance premiums) may be only a fraction of the savings that the estate, and ultimately the heirs, will realize in comparison to the other alternatives. Because life insurance proceeds will help pay the estate s obligations, capital assets may be preserved for the enjoyment of the heirs, and the administration of the estate will be substantially eased and much less costly. Life Insurance Represents a Variety of Possibilities The life insurance solution itself represents a variety of possibilities, depending on the specific size and needs of the estate, and the desires of the client and their heirs. Most often, however, the client will not want the insurance death proceeds exposed to estate taxation. Where this may be a problem, the client must not own nor have any rights in the life insurance policy. In such cases, the life insurance will be owned by an adult heir or by some third party, typically an irrevocable life insurance trust (ILIT). Meeting the Liquidity Shortfall What is the real financial effect of these options for satisfying the estate s cash obligations? For simplicity, let s imagine that the client s estate is worth $10 million and is completely tied up in a closely-held business. Despite this extreme lack of liquidity, the client believes that the estate will probably owe approximately $5 million in settlement costs for taxes, debts and expenses. If the client does nothing, then the executor will have to raise $5 million in cash when the client dies. If the executor must sell assets of the business quickly, buyers may demand bargain prices. Perhaps the sale of $7 million worth of assets will net the needed $5 million in cash, disregarding commissions, advertising costs and other selling expenses. After paying the $5 million of settlement costs with this case, business assets of only $3 million remain in the estate for the heirs. Alternatively, the executor could borrow the $5 million from a willing lender. In this case, even the U.S. government could make a de facto loan under IRC Section The executor could use the loan proceeds to pay the settlement costs, but would somehow have to raise cash to repay the loan with interest. This might be accomplished through the careful sale of business assets at their full value, but more assets would have to be sold to cover interest charges of, for example, $2 million. So again, $7 million of business assets end up being sold, leaving a net of $3 million remaining in the estate for the heirs. 3

5 On the other hand, the client might create an irrevocable life insurance trust, which may purchase $5 million worth of life insurance at a hypothetical total premium cost of $2 million. As the business was the ultimate source of these premiums, the cost might reduce the value of the estate to $8 million. But if the $5 million death benefit is used to pay the settlement costs, the entire $8 million left in the estate would pass to the heirs. 1 In real life, particulars vary widely and often the result would be less marked, especially if a present value analysis is applied. However, you can dramatically illustrate these principles described for your client with the Estate Liquidity Review. Meeting the Liquidity Shortfall Method Sell Capital Assets at Death Borrow Cash at Death Buy Life Insurance Prior to Death Source of Funds Immediate sale of capital assets Immediate loan, repaid by the sale of assets or by the heirs using their own assets Life insurance death proceeds Disposition of Capital Asset or Equivalent Estate asset is gone Estate asset or heir s equivalent is gone Preserved Additional Direct Cost Discount on forced sale Debt service Life insurance premiums Additional Indirect Costs Loss of earning power of assets & costs of selling Loss of earning power of asset and cost of keeping estate open Legal cost to create ILIT, if desired 1 The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. This example does not represent any specific product, nor does it reflect sales charges or other expenses that may be required for some investments. 4

6 The Estate Liquidity Prospect The need for estate liquidity and therefore an Estate Liquidity Review is very widespread. However, the need is most acute among people with high proportions of illiquid assets in estates that are likely to be exposed to federal and/or state death taxes: Estates expected to be worth $5.5 million or more for single clients or $11 million or more for married clients Whose estates are dominated by a closely-held business interest or real estate, and Who have children or other beneficiaries whom they hope will gain maximum benefit from their estate after they die. Using the Factfinder The Estate Liquidity Review should proceed reasonably quickly. Your immediate objective is to determine an appropriate amount of life insurance to recommend for this single need. The Factfinder is your first tool toward that end. Transition to Estate Planning The Estate Liquidity Review approach assumes that the client is not initially interested in a full estate analysis that would lead to a complete estate plan. However, during the course of quantifying the liquidity need and developing a solution for it, both you and your client may discover a need to integrate this solution with the solution to some other estate planning problems. This moves the procedure from a relatively simple liquidity review to a more involved estate analysis. For more information about the Estate Liquidity Review, please contact Voya Advanced Sales at , Option 4. 5

7 Estate Liquidity Review Factfinder Name Date of Birth Home Address Phone Number Health Status q Tobacco q Non-Tobacco Spouse s Name Date of Birth Health Status q Tobacco q Non-Tobacco Total Estate Assets Total Estate Liabilities Home $ Home Mortgage $ Real Estate Other Mortgages Personal Property Debts Securities Notes Payable Business Interests Other Checking/Savings Other Retirement Plans Other Life Insurance (DB) Owned by client and/or spouse Life Insurance (DB) Owned by third party but available for estate liquidity Other Other Total $ Total $ Will/Trust Arrangements: q All to spouse q Client: All to spouse with $ to others q Spouse: All to client with $ to others q All to others q None q Other (please describe) Have client or spouse used any of the exemption equivalent available for living gifts? q Yes q No If Yes, in what amount? Client: $ Spouse: $ Do client or spouse make any annual exclusion gifts (up to $14,000/year/person)? q Yes q No If yes, to whom? Other information (such as special concerns, needs or arrangements for children, parents, etc.) 6

8 Log on to Voya for Professionals at voyaprofessionals.com. Not FDIC/NCUA Insured Not A Deposit Of A Bank Not Bank Guaranteed May Lose Value Not Insured By Any Federal Government Agency These materials are not intended to and cannot be used to avoid tax penalties and they were prepared to support the promotion or marketing of the matters addressed in this document. Each taxpayer should seek advice from an independent tax advisor. The Voya Life Companies and their agents and representatives do not give tax or legal or accounting advice. This information is general in nature and not comprehensive, the applicable laws may change and the strategies suggested may not be suitable for everyone. Clients should seek advice from their tax and legal advisors regarding their individual situation. Life insurance products are issued by ReliaStar Life Insurance Company (Minneapolis, MN), ReliaStar Life Insurance Company of New York (Woodbury, NY) and Security Life of Denver Insurance Company (Denver, CO). Within the state of New York, only ReliaStar Life Insurance Company of New York is admitted and its products issued. All are members of the Voya family of companies Voya Services Company. All rights reserved. CN /01/2014 Voya.com