A too-common mistake that financial advisers make is to focus solely on those assets that generate monthly statements: the bank accounts and stocks and mutual funds. But those liquid assets typically represent less than half — actually more like 45 percent — of a wealthy person’s portfolio. No good estate plan can afford to ignore the other assets, the ones called “illiquid.”
That category includes anything that can’t readily be converted to cash, in a regulated market with readily determined prices. Common types are real estate, collectables, or ownership interests in privately held businesses. Other examples are livestock, mineral rights and timber, and certain financial instruments that don’t have a ready market. Those can include hedge funds, options, stock in non-public corporations, and certain debt securities.
Failing to take illiquid assets seriously is a mistake for both advisors and their clients.
The most important consequences won’t be felt until after the client’s death. First involves payment of estate taxes, which are levied on the value of inheritable assets transferable to heirs over a certain amount. Those taxes are due within months. But if a sizeable portion of those assets are illiquid, they may well have to be sold to raise the cash needed to pay those taxes or debts of the estate.
Therein lies a dilemma for the heirs.
Many assets can’t be sold — at least not for their real value — within that tight nine-month window or during a reasonable estate administration time frame. For example, real estate in a region with a depressed market can easily take a year or more to sell. Having to sell illiquid assets quickly — such as to settle an estate — may require accepting less than market value.
It’s not just taxes that may require raising ready cash. Many a will divides an estate among heirs in a way that has little relationship to the actual value of various assets. For example, if three children are each left a third of an estate that consists of two-thirds real estate and one-third cash or other liquid assets, that real estate may need to be sold if the heirs are unable or unwilling to own an undivided interest in the real estate property together.
That example is fairly simplistic. Maybe more typical is a situation in which the amount of cash needed to settle the estate is far less than the actual value of the illiquid asset that has to be sold. Maybe it’s a family farm, or a family business. Or a beloved family home or other heirloom.
Yet the only way to get cash from the valuable asset is to sell it.
That can mean something that ought to be passed to the next generation can’t be.
This doesn’t need to happen.
Careful estate planning can ensure such assets are transferred systematically. (In November 2019, I discussed some specifics about succession planning for family businesses.)
While it’s inevitable, death isn’t always predictable; taxes usually are. Thoughtful estate planning will anticipate what’s needed to pay estate taxes — significant only on large estates — and make provisions to come up with the necessary cash without having to sell off land, the family home, business or collectibles.
And that doesn’t necessarily require elaborate measures. A very simple option that’s often overlooked is life insurance. A policy of the proper kind will guarantee that a specific sum will be available at the owner’s death, so it’s not necessary to sell off those illiquid assets. Another important benefit of life insurance in situations like this is that the proceeds aren’t taxable for estate death tax purposes if payable to a named beneficiary and the owner of the policy is not the insured. Also, in this scenario, the insurance proceeds are not subject to income tax. This life insurance plan typically hinges on who the named beneficiary is, so pay close attention to that when taking out a policy.
In many situations, a trust is the most useful approach to minimizing the financial burden on heirs. Those assets, whether land or art or classic cars or a coin collection, can be placed into a trust. Those assets remain in the trust at the owner’s death; they don’t have to be sold. This can give the trust’s beneficiaries and trustees some time to work out, at leisure, a plan to liquidate its assets and redistribute them if that’s necessary or desirable.
Before deciding on the best strategy, of course, it’s necessary to do a bit of homework. A good estate-planning advisor will ask the client to make an inventory. Not just of obvious assets like real estate, vehicles and boats, but also of jewelry, antiques and other fine furnishings, artwork and the like. Perhaps even such intellectual property as copyrights or patents. Whether you intend to have these sold upon your death, or leave them to heirs, it’s important to assign a value to everything. A professional appraisal, by someone with experience in the specific types of property, is the best way to establish value for such hard-to-liquidate assets.
While an inventory has obvious advantages in terms of managing death taxes, it will also minimize the possibility of disputes and ill-will among heirs, some of whom may feel slighted if they perceive others might have been unfairly favored.
Several years ago, a well-known Hollywood personality died in an accident. He had a large collection of classic cars, but had never created a detailed inventory. The result was a huge fight, involving lawsuits, between his heirs and a friend who was accused of taking some of those cars for himself.
In another example, the story had a happier ending. A retired Iowa farmer left a huge collection of antique tractors to his family. Because he had also left a detailed inventory, specifying which of the vintage machines were most important to him, his heirs were able to decide which to keep in an intact family collection, and which could be sold to raise cash. The late owner’s foresight in making his list, and expressing his wishes, made a huge difference in simplifying things for his family, and helping maintain family harmony.
That gets to a related matter. Certain illiquid assets have non-monetary value. You may want specific family heirlooms to go to relatives who either have shown a special interest or appreciation for them, or that you believe will best be able to care for them. Just as the Iowa tractor collector did, part of the inventory process should include documenting your judgments about what you’d prefer to have transferred intact, and what could just as well be sold off so heirs can get the cash.
However the ultimate strategy is determined, however, it’s essential that any estate plan take all assets, both liquid and illiquid, into equal consideration. Experienced professional guidance will help you make the plan that best achieves your objectives and minimizes headaches for your heirs. The experts at Old North State Trust will offer relevant, objective advice on how to ensure those hard-to-sell possessions get passed down to the next generations the you wish.
As Marketing Director, Alyce works to develop, budget, and implement marketing plans, which include advertising, coordination of conferences, special events, and development and maintenance of marketing materials. She also oversees the company’s website, in-house articles, and fostering community initiatives within the organization. Alyce received a BS degree in Interior Design from East Carolina University with a concentration in Business Administration and obtained her teaching certification from UNCW. Old North State Trust professionals have many years of experience and for over a decade have assisted clients in identifying and reaching their financial goals. For more information, visit www.oldnorthstatetrust.com or call 910-399-5470.
Staff Reports - Jan 31, 2023
Cece Nunn - Jan 31, 2023
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