When people think about estate planning, they often focus on one question: Who gets what?
Who inherits the business? Who gets the real estate? How are investment accounts divided?
But there is another question that can matter just as much:
Where will the cash come from when someone dies?
That may sound like an odd concern for a wealthy family. But a high net worth does not necessarily mean a highly liquid estate.
Consider a business owner with a $10 million estate:
- $6 million family business
- $2 million real estate
- $1.5 million in retirement and investment accounts
- $500,000 in cash and other assets
On paper, this family is wealthy. But most of that wealth is tied up in assets that cannot necessarily be turned into cash quickly, or that the family may not want to sell at all.
That can create a problem at exactly the wrong time.
An estate may need liquidity to pay debts, taxes, administrative expenses, maintain property, satisfy business obligations, or create a fair inheritance among beneficiaries. If enough cash is not available, the family may be forced to sell investments, borrow against assets, or liquidate part of a business or real estate portfolio simply to make the estate plan work.
In other words, the need for cash can end up dictating what happens to assets the family intended to keep.
Life Insurance as an Estate-Planning Asset
This is where life insurance can play a very different role from the one most people associate with it.
During a person’s working years, life insurance is often viewed as income replacement: if someone dies unexpectedly, the death benefit helps support a surviving spouse or children.
For affluent families, however, life insurance can also be used to create liquidity at death.
Suppose a parent owns a $5 million family business and wants that business to pass to the child who works in it. Another child is not involved in the company.
Splitting the business 50/50 may create conflict. Selling it defeats the purpose of keeping it in the family. And there may not be enough other assets to provide the second child with a comparable inheritance.
A life insurance policy can potentially create an entirely new pool of cash at death, making it easier to preserve the business while still providing for other beneficiaries.
But ownership of the policy matters.
Life insurance death benefits are generally received income-tax-free, but that does not automatically mean the proceeds are outside the insured’s taxable estate. One strategy used in more advanced estate planning is an Irrevocable Life Insurance Trust, or ILIT.
With an ILIT, the trust, rather than the insured individual, owns the life insurance policy. When properly structured, the death benefit can remain outside the insured’s taxable estate while creating liquidity for heirs. The source article that inspired this discussion describes ILITs similarly: as a way to provide heirs with cash to cover estate obligations without forcing the sale of a family home or other core assets.
The Goal Is Not Just Tax Reduction
It is easy to think of an ILIT purely as an estate-tax strategy. But the broader planning concept is more useful:
If your estate plan depends on keeping certain assets intact, you also need a plan for where cash will come from.
That may be especially important for families with closely held businesses, rental properties, farms, concentrated real estate holdings, or other assets that may be valuable but difficult to divide.
An ILIT is not appropriate for everyone. It is irrevocable; the insured generally must give up meaningful ownership rights in the policy, and the trust must be carefully designed and administered. Existing policies can also introduce additional planning considerations.
The life insurance itself still has to make economic sense. A trust does not turn a poor insurance decision into a good one.
But for the right family, the strategy can solve a problem that a simple net-worth statement does not reveal.
At Hanover Advisors, we believe estate planning should go beyond deciding who inherits each account or property. A coordinated plan should also consider taxes, liquidity, business succession, beneficiary fairness, and how the pieces will actually work together when the time comes.
Because being wealthy on paper is not the same thing as having the cash necessary to carry out your plan.