Executors need cash. For taxes, donations, fees and costs, liquidating liabilities and guarantees, and for equalizing legacies. Most will not have enough. Many people focus on estate costs and overlook the cost to get the money to pay them.
Prudent planning says that estate liquidity must be addressed. Here’s why.
Every estate has costs. Making them all go away while living is usually not possible without prepaying things like taxes or by taking chances like using joint ownership with children. These sometimes work and should be considered but often minimize the estate too.
The idea is to find the combination of techniques that leaves the lowest possible amount owing in the estate. The irreducible cash requirement.
Some people talk about estate costs and tax costs and such. Useful but incomplete. The required thought is, “These things are certain. They will go away by writing a check. The uncertainty is where will the deposit that covers the check come from.”
There are exactly four ways for cash to appear in your estate. Two your executor controls and two that you control.
Your executor controls “Sell something,” and “borrow.” Either could work but at a price. You need to know the questions to ask before setting out on this course.
Sell Something – To whom? For how much? How quickly?
“Estate sale” normally means bargain. Buyers know and expect that. Then there are fees; real estate commissions for example. The “executor year” in the income tax act imposes a deadline. Deadlines seldom add value. You can usually count on shrinking value by at least 10% and more probably 20%
Borrow – From whom? How much? What terms?
“Borrow” will tend to keep the estate from selling at a bad price but it slows down administration. The executor will need to pledge at least 75% of the estate assets to get 30% of it in cash, and for a long time. Remember – no management, not much liquidity, and maybe limited cash flow. The lender will expect a sale in the near future to liquidate the debt. Any interest paid in the interim is not tax deductible so that likely has a negative economic impact close to double the rate charged. Borrowing is usually just a deferred sale and often with the loss of some tax advantages.
The deceased controlled two choices. Own cash or own life insurance. Each of these has a cost and questions.
Own cash – What is the opportunity cost? How is it taxed? What is the risk?
Owning an investment portfolio might suffice and avoid the ongoing opportunity cost, but if the market fluctuations happen wrong, then what? Owning cashable securities or money market funds avoids fluctuations but costs yield in the interim and is taxed the worst.
Own life insurance – How much is the premium?
Life insurance is a conditional option on money. You pay the option price each year and if the conditional event (death) occurs, then the agreed amount goes to the estate. Assuming the potential deceased has decided to not burden his executor with option 1 or 2, then the easy way to think about value is take the liquid cash and set aside enough to pay the premiums. Maybe a life annuity. How much is leftover? That is the profit from owning life insurance. Go buy a Porsche or a condo in Miami Beach. The difference will not be insignificant.
If you don’t have the cash already, how exactly were you expecting your executors and heirs to pay the bills?
Harvey McKay says, “If you have a problem you can solve by writing a check, you don’t have a problem, you have an expense.” Minimizing the expense to get the money for your estate is a part of estate planning. Do the arithmetic. Life insurance is the cheapest.
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Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: firstname.lastname@example.org