The Basics of Estate Equalization

We have helped countless farmers in the Central Valley set up Estate Equalization plans for their families. Estate Equalization allows one of the children to inherit the farm, without leaving the other children in a "lesser" situation. The “Equalization” part of Estate Equalization allows you to pass on an equal amount of wealth to your beneficiaries in a tax efficient way. This blog gives a good example of how we do so.

Estate Equalization is a crucial concept for affluent business owners to utilize in order to pass on their estate, as well as their business, to the next generation in an equal and fair manner to their children. All too often when Estate Equalization is not utilized, family members can come into nasty conflict over their parents’ assets. What Estate Equalization in essence does, is that a plan is created that outlines who receives what. If the parents have multiple children, perhaps only one of the children intends on taking over the family business. If no plan is created, then the child that takes over the family business is greatly enriched while the other children are left with little to nothing. Situations like these are very common, and can cause great strain in the relationships of siblings. With Estate Equalization, not only can you prevent these inequalities, but you can also grow your assets, protect them by using tax-free life insurance distributions that helps pay any estate taxes that become due, all while creating another supplemental income stream during retirement.

Let’s look at some of the issues that Estate Equalization solves…

Example:

Stephen (74) and Ellen (72) have three children. Stephen has a business worth approximately $15 million and has seen growth of roughly 3% over the years. Stephen and Ellen’s oldest son, Jack, works in the family business, while the other two children, Landon and Sophie, work in other industries. Stephen and Ellen’s plan is for Jack to take over the business once they pass, but they want Landon and Sophie to inherit a similar amount as well.

A simplified look of their scenario would look something like this.

As we can see by the illustration, the business is projected to grow to approximately $22-24 million by the time Stephen and Ellen hit their approximate life expectancies. If current legislation stays in place, then the children will be looking at having to pay a Federal Estate Tax of around $4 million. If no plan is in place, it is likely that they would have to liquidate part of the assets in the business to fund this Federal Estate Tax. However, if Stephen and Ellen put a plan into place, then this issue can be avoided.

Let’s look at how the Estate Tax problem can be solved, as well as equalizing the assets between the children.

The illustration shows the flow of assets from the parents to the children. As previously stated, Jack is set to take over the business once his parents pass. If we assume that Stephen and Ellen pass near their expected life expectancy, then Jack would be good for around $20 - 25 million. However, a $4 - 4.5 million Estate Tax would be due. It may be difficult for Jack to come up with this money without having to sell off significant assets of the business, assets that may even be needed for the business to operate. What Stephen and Ellen could do, is purchase a permanent life insurance policy with a death benefit of $5 million. This way, Jack could use the proceeds from the life insurance death benefit to pay the Estate Tax.

With all this in mind, Jack inherits the business which is valued at approximately $20 - $25 million after paying the Estate Tax. What Stephen and Ellen can do is purchase additional permanent life insurance policies with death benefits of $20 million where Landon is named beneficiary of one policy, and Sophie the beneficiary of the other. This way, after the passing of Stephen and Ellen, each child has inherited approximately $20 million.

Below is the updated flow chart with life insurance proceeds attached.

Notice that without planning, the total estate passed on to their children would be in total roughly $20 million (Value of Business minus Estate Tax). With proper planning, Stephen and Ellen were able to grow their assets and pass on 3 times the amount to their children for a total of around $60 million.

Now, you may ask how much does the life insurance cost? Normally in these cases, we do not use a client’s money to pay for the life insurance premiums. Instead, we take loans from one of the many banks we work with. In good interest rate environments, we can lock in rates as low as 2-3%. With growth through crediting in the life insurance policies often exceeding 7-8%, we can net positive, and at the end of a period, we use the excess crediting to pay the loan + any interest due back to the bank. Even after this, we are often left with large amounts of excess cash that the parents could use as supplemental income should they desire more retirement income.

Don't leave your family's financial future to chance. Safeguard your legacy and ensure harmony among your loved ones with a tailored estate equalization strategy. Contact our team of experienced professionals today to discuss your unique situation and discover how we can help you create a plan that benefits everyone involved. Take the first step towards a secure and prosperous future for your family – get in touch with us now!

(559) 322-2230

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