What Is Estate Equalization? - PolicyAdvisor
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What is estate equalization?

SUMMARY

Choosing how to divide your personal and business estate can be tricky, depending on how involved your beneficiaries intend to be in the management of your estate’s assets. Estate equalization is a unique approach for business owners to divide their estate equally and fairly, usually by utilizing a life insurance death benefit.

By Jiten Puri
CEO & Founder, Insurance Advisor, LLQP
9 min read
IN THIS ARTICLE

When we discuss life insurance, it usually relates to protecting your family’s financial affairs in case of your death. But life insurance policies also have significant uses in estate planning

Estate equalization is a unique strategy that leverages life insurance to help business owners fairly pass on their business and financial assets to the next generation.

This article reviews the concepts of estates and estate planning, how they mingle with your business assets, and how to use a life insurance policy for estate equalization to facilitate the equitable passage of your business to the next generation.

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What is an estate?

An estate is everything you own at your death. This includes real estate holdings, personal property, and cash. At your death, your estate is generally divided amongst your beneficiaries as determined in your will. However, if you pass away without a will, provincial estate laws decide how your estate is administered — it’s usually passed along to your spouse, children, or other family members. 

Estate planning organizes your assets so you can pass them on in the most tax-efficient manner to specific people or charitable causes upon your death. Estate planners need to consider probate fees, taxes, and the potential for disputes between your beneficiaries. Successful estate planning not only minimizes taxes but also mitigates any future family feuds over your assets in court. Life insurance is often an important component of the estate planning process. 

For business owners, your business shares and assets complicate this process. In addition to usual estate planning issues, you now need to consider business partners, shareholder agreements, and other business relationships. Poor estate planning by business owners can create burdens on not only the surviving beneficiaries, but the business itself—sometimes causing it to fold under financial strain.

For example, suppose Joe passes away and leaves half of his family business to his son and half to his daughter. The adult children may ultimately disagree on how to run the business and end up in court. Such a situation could shift the son and daughter’s focus away from the company and onto legal disputes, which eventually may cause the company’s downfall. This situation is not ideal but can be avoided through careful business estate planning.

What are my business’s assets?

If you run a sole proprietorship, your business’s assets are usually part of your estate. In contrast, if your business is a corporation, your estate holds your proportionate shares of that corporation instead. In either case, your succession plan must consider how to divide these estate assets between your beneficiaries.

Many beneficiaries may not want to inherit the business assets but may instead want to access the monetary, or liquidation, value of the business. Suppose your estate comprises of specialized business equipment for IT services. Some of your beneficiaries would prefer for an estate administrator to sell these assets and divide the proceeds amongst the beneficiaries instead of giving them company ownership and control of the IT services equipment. But not all assets can be easily sold. That’s why you need to consider how liquid your business assets are when planning your estate.

Liquid assets are assets that can easily be converted to cash. Or even better, they are cash. Other examples include stocks, bonds, or certain types of real estate. 

Non-liquid or illiquid assets are assets that are not easily convertible to cash. They may not have buyers at any given moment. For example, if you own a private business that isn’t in a very lucrative industry, it may be challenging to find someone to purchase your shares in that business. This could create difficulty in distributing your estate as beneficiaries may not want the private business shares and prefer cash. 

Furthermore, it’s important to take stock of your liquid and -illiquid assets ahead of your estate planning, so you can figure out your preferred way of passing along your legacy.

What is estate equalization?

Estate equalization is a strategy that allows business owners to fairly divide their estate amongst multiple heirs. An estate equalization allows a business owner with multiple children (or other beneficiaries) to split their assets in an equitable and fair manner across the multiple beneficiaries. For instance, through this strategy, the business owner may pass on their entire business to the beneficiary who wants to continue running the company. At the same time, the rest of the owner’s estate, which usually comprises of their life insurance payout, could be passed on to the other child or beneficiaries. This way, the business survives onto the next generation, and no beneficiaries feel unfairly treated with the asset distribution.

How can life insurance be used for estate equalization?

A life insurance policy can provide the necessary liquidity to grant each heir the intended and equal share of the inheritance. Through its non-taxable death benefit, life insurance can provide a discrete monetary payout to create balanced estate distribution of assets between family members—those that want shares in the active business get the shares, but those that don’t get the life insurance payout. 

For example, suppose Victoria is a family business owner and has a son and a daughter. Her son works for a big bank and doesn’t pay much attention to Victoria’s thriving business. However, Victoria’s daughter acts as the business’s general manager. Victoria’s estate is comprised primarily of her family business assets. Because her daughter is so heavily involved, Victoria may feel her daughter has an entitlement to the business and want her daughter to take over after she dies. Therefore, Victoria decides to pass the entirety of her business to her daughter through her will. She then designates her son as the sole beneficiary of her life insurance policy to ensure he’s fairly treated. 

Effective estate equalization ultimately provides fairness to your beneficiaries without the need to break up your business or sell your shares for cash to avoid a family dispute. It’s also used with assets like a family property, such as a cottage. Calculating family property value may come down to two aspects: monetary and emotional value. You and your family may not want the cottage sold at your death. But it could be hard to divide the family property otherwise. Alternatively, one child may want to keep the cottage while another wants cash. If the first child can’t afford to buy the second child’s share of the family property, an estate equalization could allow one child to keep the cottage while the other child receives the life insurance death benefit.

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How does estate equalization with life insurance work?

The estate planning process requires laying out your intended distribution plan for your personal and business assets. You create a list of distributable assets and choose a focus year in the future at which time assets may have to be distributed. A reasonable set of projections are then created to establish the likely valuation of the distributable assets at that time. You also have to consider future heirs that may get involved and may seek a share of the asset distribution. 

A life insurance policy is then purchased on the life of the business owner. The projected death benefit as included in the policy illustrations is then used to identify the amount of coverage to be purchased to evenly balance out the value of the other distributable assets, such as the family business.

Life insurance comes in different forms and term lengths, depending on your personal and business succession plan’s needs. For example, term life insurance policies include a death benefit to pass along to your family and usually cost less in premium as the term can expire before a payout. Whole Life Insurance, with its emphasis on lifelong protection and potential for cash value growth, can be an especially attractive choice for an estate equalization plan. You could invest in a corporate-owned life insurance plan so the next generation can afford to buy your business if you pass away. Permanent policies may have an investment component in addition to the death benefit that you can also use to protect the transfer of your business from taxes. Life insurance comes with many other benefits when you place the policy in the business name.

How else can I use insurance for other aspects of estate planning?

Estate planning is about more than just your death. It also considers unfortunate circumstances, such as if you become incapacitated or disabled from a personal injury or illness. In such a scenario, you may need documentation such as a power of attorney so that another person can make business and personal decisions on your behalf. 

If you become incapacitated, even temporarily, you may lose a substantial portion of your income. Your family may lose you as an income source, but you may be ineligible to receive your life insurance payout because you’re still alive. This could ultimately create financial difficulties. In this case, products such as critical illness or disability insurance can keep your loved ones financially intact. 

Building an estate plan for your personal and business assets ensures that your family’s financial stability continues after your death. Estate equalization ensures fairness among your beneficiaries while maintaining the survivability of your business. It ultimately will allow the beneficiaries to focus on supporting each other rather than squabbling over your assets. 

PolicyAdvisor’s licensed insurance experts can help you better understand what insurance products may be best for your business estate plan. Book some time with us below and see how our insurance products can help you smoothly pass along your business legacy. 

The information provided herein is for general informational purposes only. It is not intended and should not be construed to constitute legal or financial advice.

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KEY TAKEAWAYS

  • Estate equalization is a process where business owners fairly distribute their liquid and non-liquid assets
  • Life insurance can be used in estate planning to equalize the estate—it offers monetary compensation for those who don’t want to inherit the business
  • Including life insurance in your estate plan will ensure that your business and family remain financially secure

By Jiten Puri
CEO & Founder, Insurance Advisor, LLQP
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