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Using Life Insurance for Estate Equalization

Written by Chris Nolt

A common dilemma among many agricultural families is deciding how to leave a fair inheritance for each of their children. Oftentimes, one child has stayed home to operate the farm or ranch, and the other children have pursued different careers. While the parents desire to be fair to each of their children, they typically don’t have enough other assets to leave their off-farm child or children a fair inheritance. And, because the farm or ranch doesn’t usually generate enough income for the on-farm child to buy-out his siblings, the family is unsure what to do.

As a way to equalize inheritance, parents can purchase life insurance for the benefit of their off-farm children.

In the example below, we will examine a common scenario among agricultural families and explore three solutions using life insurance to achieve the family’s financial goals.

Bob and Nancy own an $8 million ranch in Wyoming. They are both in their mid-60s and have three children – Stan, Mike and Sherry. Aside from the ranch assets, they have savings and investments of $150,000.

Bob and Nancy’s son Stan has lived and worked on the ranch his entire life. They pay Stan an annual salary of $30,000. Mike and Sherry have other careers and are not interested in coming back to the ranch.

Bob and Nancy would like to pass the ranch to Stan and provide a “fair” inheritance to Mike and Sherry. Their goal is to leave Mike and Sherry an inheritance equal to half of the current value of the ranch divided equally between them. Bob and Nancy meet with their advisory team to explore options for providing Mike and Sherry each with $2 million.

The first option is to save.

The family estimates Bob and Nancy’s joint life expectancy to be 20 years. Assuming they could earn an average annual return of six percent on an investment, they calculate they would need to save over $110,000 per year for 20 years to come up with $4 million to leave Mike and Sherry.

Option one won’t work.

Bob and Nancy also have the option to borrow.

They call their local banker and Farm Credit Services representative to see how much it would cost for Stan to borrow $4 million. Using a fixed interest rate of six percent and a term of 10 years, Stan’s monthly payment would be nearly $26,400. Over 20 years, his payments would total over $6.3 million.

Option two won’t work.

Their third option is to insure.

The family obtains quotes on a $4 million survivorship life insurance policy on Bob and Nancy’s lives. Based on standard ratings, the annual premium would be approximately $60,000. The family concludes that using life insurance to equalize the estate is the best option.

Three potential solutions are presented involving life insurance.

First, Bob and Nancy might establish an Irrevocable Life Insurance Trust (ILIT) and purchase a $4 million dollar survivorship life insurance policy with the ILIT as owner and beneficiary of the life insurance policy. Bob and Nancy name their two off-farm children, Mike and Sherry as beneficiaries of the ILIT.

When Bob and Nancy pass on, Stan inherits the ranch, and Mike and Sherry split the $4 million life insurance proceeds equally.

Another solution would be for Bob and Nancy, in their wills or living trust, to provide for a distribution of a one-half interest in the ranch to Stan and a one-quarter interest each to Mike and Sherry. During their lifetimes, they have Stan, Mike and Sherry execute a binding cross-purchase agreement whereby Stan agrees to buy-out, at fair market value, the one-quarter interests at $1 million each, which will be distributed to Mike and Sherry.

Stan then purchases a $2 million survivorship life insurance policy on Bob and Nancy. If he needs additional funds to pay the premiums on the policy, the ranch may be in a position to increase his salary or bonus additional money to him on an annual basis.

Upon the second to die of Bob and Nancy, Stan uses the death benefit to acquire their interest, per the cross-purchase agreement.

As a third option, the family determines they cannot afford the $60,000 annual life insurance premium. To come up with the money to pay the annual premium, they decide to sell a lesser productive portion of their land, valued at $1 million, through a Charitable Remainder Trust (CRT) and use the annual income from the CRT to pay the annual life insurance premium.

Because the CRT is a tax-exempt entity, it will not have to pay capital gain tax on the sale. Assuming they net $1 million from the sale of land and select a six percent payout in the CRT, they will receive approximately $60,000 per year from the CRT.

They will use this income to pay the annual life insurance premiums.

Life insurance can be an effective tool for an agricultural family. There are many types of life insurance polices and many ways of structuring policies for achieving one’s goals. There are also serious tax ramifications associated with the ownership of life insurance. It is important to work with an experienced independent agent and to involve the assistance of an estate planning attorney.

Chris Nolt is the owner of Solid Rock Wealth Management and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families selling a farm or ranch and transitioning into retirement. For more information, call 406-582-1264 or visit solidrockwealth.com and solidrockproperty.com.