HELP! Illiquid Assets In My Mom’s Estate
How often do wealthy families holding illiquid assets—an art collection, a horse farm, a real estate portfolio—worry about paying estate taxes when the parent generation passes? They discuss it all the time. How soon do they act on this obvious and dire need? The honest answer is sometimes never, but more often belatedly and in a sudden rush after years of inaction.
Assume the Jackson family owns a successful vineyard that is now worth $100 million. The father recently passed at age 76, leaving the family vineyard to Mom, who is 71. The father refused to acknowledge his mortality and wanted nothing to do with estate planning, and now a huge financial burden is dropped in Mom’s lap. How worried is she? It is fair to say that she is scared to death.
Mom can work with her financial advisors to implement various tax strategies, including transfers and gifting of equity interests in the vineyard to children and grandchildren, but a key element of this plan will be to provide liquidity to the estate in order to pay estate taxes and keep the vineyard in the family.
The advisors recommend an ILIT holding a life insurance policy with a death benefit of $10 million and an annual premium of $330,000, and a term through age 105. The annual premiums are funded from the vineyard’s revenue, and Crummey withdrawal powers will let Mom take advantage of annual gift exclusions to preserve her lifetime unified credit as much as possible. Mom has four adult children as well as 10 grandchildren, and so the first $210,000 of premiums per year ($15,000 x 14 beneficiaries) can be contributed without impacting her lifetime unified credit amount. Under the Cristofani case, Mom may be able to add nieces and nephews to the power of withdrawal, even though they are not beneficiaries of the trust, to enhance the annual exclusion utilization.
Premium contributions in excess of the amount subject to Crummey withdrawal powers will be a taxable gift by Mom, but such gifts can be offset by her unified credit amount (which works well if the unified credit is not needed for other wealth transfers).
Assume the family picks a guaranteed universal life policy, guaranteed through age 105, with a $10 million death benefit. The arrangement achieves these objectives:
• If Mom passes the next day, there is $10 million immediately available to deal with estate tax liabilities—this amount does not solve the estate tax problem fully but does provide the first $10 million toward solving the problem.
• If she dies after 10 years, she will have invested $3,300,000 with a return of $10 million, a return of greater than 200%.
• If she dies at 15 years, she will have invested $4,950,000 with a return of $10 million, a return of greater than 100%.
• If she dies at 20 years, she will have invested $6,600,000 and with a return of $10 million, a return of greater than 50%—which is no longer impressive, but after 20 years the estate has in effect bought time to address its liquidity issues in other ways.
• If she lives 35 more years, to age 106, the policy will lapse and will no longer have value. Mom by that time will have paid $9,570,000 (premium payments often end at age 100) and all she will have is the satisfaction of living to age 106. Who wouldn’t be happy to take that deal?
The bottom line for ILITs and for this article is that the ILIT is a very flexible and sophisticated estate-planning vehicle that can be used to solve problems in a variety of challenging life (and death) situations.
Joseph B. Darby III, Esq., is an adjunct professor at the Boston University School of Law and the founding shareholder of Joseph Darby Law PC, a law firm that concentrates on sophisticated tax and estate planning for individuals and businesses.
Kimberly A. Furnald is an estate planning and private business solutions specialist focused on creative insurance-based solutions for individuals and private business owners at Penn Mutual in the Boston area.