Estate Equalization Case Study

Client Profile and Common Concerns

• Married clients in their early 60’s with a net worth of approximately $45mm. 
• The largest component of their net worth is a family owned auto-dealership; roughly 44% of the total estate. 
• Clients have three adult children that they wish to treat as equally as possible. However, only one of the three children is actively involved in the business. 
  • Clients recognize the conflict that can arise when an operating business is divided among active and inactive family members. Given this, they would like to transfer the entire business to the participating child. 
  • They would like to equalize the inheritances for the non-participating children but have limited additional assets with which to do so.
  • Clients are also concerned about a potential estate tax liability. 

Questions to Ask

• What estate and business succession planning has already been completed?
• How are the auto dealership assets (i.e. land, buildings, equipment) owned?
• Who are the current owners of the business assets?
• Who will be inheriting the dealership?
• What other assets do you own?
  • A portion of other assets being assigned to inactive children would be retirement accounts, subject to tax at ordinary income rates when received. Making the disparity between active/inactive children even greater.
  • Even with the current use of the client’s exemptions before it sunsets at the end of 2025, this would result in an unequal inheritance for the inactive children.

Potential Solution

• Clients use their exemptions before sunset, and then purchase a minimum of $20 million of life insurance that will supplement the amount they can pass to each of the inactive children to bring them closer to parity. 
• These clients have a high opportunity cost of capital and are comfortable with the concept and practice of using leverage as a method to fund the premiums. 

Challenges

• The most efficient designs for premium finance program often involve dropping the death benefit to the minimum amount allowable to retain the tax-free benefit of life insurance after all premiums have been funded. 
• However, given the importance of equal inheritance to the three children they can’t risk the policy falling below the required $20 million of net death benefit in the event of an untimely death, or jeopardize the long-term policy viability by leaving the death benefit high. The clients are also not thrilled about paying the increased cost of starting with a much larger policy. 

Solution

• This unique scenario led us to a solution of financing two policies for their insurance program. 
• One policy designed for maximum death benefit and the other designed for maximum cash accumulation.
  • The maximum death benefit policy will help maintain a death benefit above the target amount ($20 million of net death benefit) throughout the course of the program once the death benefit is reduced on the cash value accumulation policy. 
  • The lowest our combined death benefit ever falls is just under $20.3m, while having varying amounts of excess death benefit in most years.
  • At life expectancy the clients would project to have $30.7m in death benefit and have paid a little over $3m of total out-of-pocket expenses, resulting in a tax-free IRR of 9.25%.
     

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