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"Slicing Up the Pie"- Estate Equalization Using Life Insurance

"Slicing Up the Pie"- Estate Equalization Using Life Insurance

October 14, 2023

Estate planning for business owners looking to pass their assets to the next generation can be incredibly tricky. In situations where a business owner has more than one child but intends for only one child to inherit the business, dividing assets in a fair and equitable manner is often a top priority. If the business is illiquid, attempting to divvy up its components to satisfy the estate plan can cause major operational burdens.

Consider the hypothetical case of a business owner, Bill, who owns a successful small business. He has two adult children, Sarah and Jack. Bill intends to pass the business on to his son, Jack, as he has been actively involved in the company and has expressed a strong interest in running it. Sarah has chosen a career path outside of the family business and has expressed no desire to be involved with the it. However, Bill wants to ensure that his daughter receives her fair share of his estate. The challenge is to create a plan that enables Jack to inherit the business while also providing for Sarah in a way that is equitable. For simplicity, let us assume that Bill’s spouse predeceases him.

One Possible Solution: Estate Equalization with Life Insurance

Estate equalization is the process of making sure that the heirs receive assets of comparable value, even if they have different preferences or abilities to manage those assets. Life insurance is a valuable tool in achieving estate equalization, as it allows the insured to define the death benefit for their beneficiaries.

In Bill's case, estate equalization using life insurance can be implemented as follows:

  1. Valuation of the Business: First, Bill must determine the fair market value of his business. This valuation is what Jack stands to inherit at a stepped-up basis. For this hypothetical example, let us assume the business is valued at $3 million.
  2. Life Insurance for Sarah: To provide for Sarah, Bill can purchase a life insurance policy on his life with Sarah as the beneficiary. Bill chooses a policy with a $3 million death benefit.
  3. Equalizing the Inheritance: By using this strategy, Bill can ensure that the total value of the life insurance policy payout equals the approximate value of the business. This approach allows both children to receive assets of similar value, regardless of their involvement in the business. It also allows the business (now under Jack’s sole ownership) to continue operating smoothly.

Considerations

The hypothetical example provided above only serves to demonstrate a concept. In practice, there are numerous other considerations that will apply. What happens if Bill lives another 10 years, and the new business valuation is $5 million? What type and structure of life insurance would be most appropriate? How will the life insurance premiums be paid? Estate tax law changes and ramifications? Estate planning is often an ongoing process and is not something easily completed with a Last Will and Testament alone. Being proactive today and continuously will help ensure your beneficiaries receive their fair “slice of the pie.”


-James

The material discussed is meant for educational purposes only and is not to be construed as tax, legal, or investment advice. Please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. Consult your tax, legal, or accounting professional regarding your individual situation. 2023-163338 Exp 10/25