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Foreign.
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What is up? And welcome back, everyone, to another episode of the Practical Planner podcast. I'm your host, Thomas Kobelman, and here with me is Ann Rhodes, and we have a new guest. So today we also have Rachel Hartman joining us. She will probably be on, I would say, a decent amount of episodes moving forward for everybody listening. And we mentioned this before, but Dave ended up moving on. We love Dave. I'm sure he'll come back on for more episodes. But we're actually going to start to expand the podcast, I think, continue to do the estate planning side, but also talk just tax planning in general, which is why Rachel was a perfect fit. She now works at wealth as a tax council, but before this, she was a tax accountant at Price Waterhouse Cooper and then became a tax attorney from there. And Rachel, we're just excited to have you in on this podcast. I don't think we've had anybody in the tax space other than maybe Jarvis, I think, a few episodes ago. But thanks for joining us today. Really appreciate it. Anything else you want to add kind of on background about yourself?
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I think that, I think that sums it up well. And I'm excited to be here. I am a dweeb when it comes to tax, so any, any and anything you want to ask me, go, Go right ahead.
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B
Perfect. And honestly, I mean, like I always tell advisors, it's the easiest space to add value and stand out. Most advisors know nothing about tax. They can barely talk tax. They tell them to go talk to their cpa, their CPA says, go talk to your advisor. And then everybody's stuck in this space. We're like, somebody please give me direction and planning and proactive thinking on taxes. Because it's the easiest, in my mind, the easiest place to actually add alpha. Because you can't control stock market returns, but you can control the tax planning moves that you make. So really excited to have you here so we can talk a whole bunch of things. But for today's episode, what we're really going to be focusing on is creating liquidity at death. And before we really even dive into the strategies to help around this. And you worked with people high net worth, obviously, the more. More I would say net worth you go up on that spectrum, the more illiquidity there is. And that's where this issue mostly stems from. But kind of just give us a background on, like, where is the issue here? Like, why do we really need to even be talking about liquidity at dev.
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C
Sure. So liquidity really is, you know, your ability to generate cash. So that you can pay for things in a very short amount of time. And so when you think about death, there are some obvious reasons why liquidity comes into play. And actually, Rachel, I'm sure you also had clients who had tax issues, but then that led to liquidity issues as well. And so primarily think of paying for expenses, so funeral expenses, potentially all sorts of, maybe even income tax for that person. But also if they have their assets in businesses or real estate or some sort of asset that is illiquid, you have all sorts of costs that come with death that normally they would have handled in a different way, maybe with loans or some other form, but at death, those become more difficult to administer or to be able to handle. And so that's the reason why, as an advisor, if you have a client where you suspect, hey, at death, their family is going to struggle covering anything from their funeral expenses up to potentially estate taxes which are due within nine months of that person's death, you really need to think about what you counsel your client with respect to liquidity. And so, Rachel, maybe you have some thoughts there and we can talk about some strategies to create liquidity in the event of death.
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A
Just say that there's nothing worse than when you get to start an estate administration and you owe tax and there's nowhere for it to come from. And then you have to start going back to beneficiary saying, hey, listen, we need to pay tax, you know, time to start giving money back. So there's just always so many different things that happen. Whether it's, you know, everything is labeled as transfer on death or all you have is real estate and needs sold. So just so many things go into it that a lot of people tend to not to not think about because they don't want to pay taxes, they just want to get their assets to their beneficiaries.
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C
Yeah, I would say the two things you want to avoid, absolutely, to Rachel's point is, number one, having to force the sale of something because then you're not getting the best price on the market, potentially because you have that nine month ticking clock. And then the second thing is to claw back from beneficiaries because they somehow ended up with the liquidity and the liquid assets. So think in a prototypical way, beneficiary designations or pay on death or transfer on death designations. So all of a sudden, your bank accounts, your brokerage accounts all have these designations. They by operation of law, have already left the estate into the hands of a survivor or that beneficiary who's been Designated and then you have to call back those assets from them. That is not a good look.
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B
Yeah, so you mentioned this a couple times, but somebody passes away, estate tax is due nine months after. But what about. I think it's just good for advisors to know to help. What is the tax return for somebody after they pass away? Look, like what does that timeline is the next year and then how does it work for the surviving spouse? Right, the surviving spouse files their own tax return. Correct. But they still have like the married filing joint tax brackets for one year or two years. Do you know Rachel?
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Correct.
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So.
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So in the year of death it's still going to be a married filing joint because you know, your spouse was still alive for part of that year. And then after that they, they changed it. I think I was called technically qualify qualifying surviving spouse. Yeah, they changed, they changed what it's called for after that. But then you still get for up to two years certain things. So if you want to sell the personal residence, you could still get that full $500,000 tax tax or capital gains exclusion as opposed to just 250 as a single person. So they do give you some specific things for two years after death.
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B
Okay, super interesting. But then that's kind of the side where I'm sure there's less tax planning to do there other than like, okay, maybe you do Roth conversions and realize those years or maybe you do some capital gains harvesting. But in general, like that's not the big surprise tax bill that's going to come most likely. Unless you really didn't plan well. It really is that estate tax side. So this is really thinking more in the high net worth space to say, hey, you have nine months. We need to make sure that we plan for nine months around this. Because, you know, one question I have is what happens if your estate plan is a mess? Obviously we assume that most people over this estate tax threshold, that's not the situation. But I think we will find this to be more and more common today because I think there's never been more DIYers than there are today. Like even the people that come in to work with me, I have people coming in that are 30 to 50 million net worth with, you know, they might have some advanced tax strategies, but they don't even have a regular estate plan set up. So let's say they pass away, they have an estate tax due, but they're going to have to go through probate in California. So how does somebody plan around that when maybe these assets are going to be frozen and not even have the ability to be used within that timeframe.
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C
Yes. So there are a few strategies. And of course, I think whenever you think about liquidity and generating liquidity at death, you think insurance. And I want to just say there's life insurance and there are different forms, so we can talk about that, that. But there is actually insurance even to like pay for funeral expenses and things like that. Just because, you know, we're talking here a lot about estate taxes potentially. I just want to say to our audience, like, you may have clients where if you actually, you know, ask them what they expect, their, you know, their, how their remains might be disposed, like what kind of life celebration they're expecting, you actually come to realize that even generating liquidity for. To pay for those funeral expenses and some of those costs, or let's say they have kids who are in college, right. And they need to be able to pay tuition still, all those things might actually necessitate generating liquidity even at the mass affluent end of the spectrum. I'll give you a quick example. I had a friend whose parents were from Guatemala, and what they expected was that upon their death, they would bury their bodies in Guatemala. And so all of a sudden you think about expenses like that for a family that may not have the means normally to be able to just pull out, you know, honestly, thousands of dollars to do it, you know, that becomes a burden on the family potentially as well. So ask your clients, because you don't know, you know, if they expect like a big mausoleum to be built or something like that. Like, people have expectations of how they want the, their end of life to go. And then of course, their medical expenses as well, which, you know, are come a little bit before, you know, what we're talking about here. But still, you know, those debts, they end being debts of the estate. Right. And so paying the hospital bills, et cetera, for all of those reasons, you need to generate liquidity even at the lower end of the wealth spectrum. But Rachel, perhaps you want to give some strategies for the upper end of the spectrum where maybe the estate tax or probate, significant probate fees do come into play.
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Yeah. So whenever it comes to the upper end, you want to look more at. I mean, although I think insurance policies are always good to have no matter where you're at on this, on the spectrum, that's just not for the lower end. People also look to just make sure that there are assets that are not all transfer on death or are tied up. So they'll just take your look at your plan. Holistically and just say, okay, where can money be paid from? And if you see this automatically goes to the beneficiary and there's just at the end of the day, nothing left to go to the beneficiary. Then before you even get to big planning, you want to, you know, change some stuff to make sure that it makes sense that there are funds to pay from in the first place. So again, for example, say you want to give all the stuff to your beneficiaries, but it's all transfer on death, it's all IRAs with beneficiary designations, it's all property that's joint. So it again automatically joined by our survivorship. You want to see within there what can I do to make sure there is untied up funds whenever it comes time to pay stuff through the estate?
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B
Yeah, because you mean you could create issues here, right? Imagine that you have the scenario you just talked about, but like their taxable investments are not liquid, right? They decided, hey, we're going to have our IRAs and you know, those will get passed on to our kids. And we have a bunch of private investments in real estate. But the issue becomes where we have, okay, great, you're going to owe these taxes, but you have to distribute the entire IRA to cover these taxes. And so now you're already in a high income bracket, is probably a 40 or 50 year old, you're stacking that on top. So you're losing significant amounts of it in the highest tax bracket when you would have been better off to say, hey, let's for one, I think everybody's better off to be pretty liquid. I think a lot of mistakes, you know, wealthy make are becoming extremely illiquid in their investments. But just in general, right, like you're way better off having a step up in basis and raising funds from that than you are having to really quickly distribute an IRA and lead to more income tax.
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C
And so in terms of some of the strategies that I've seen, you know, some of these are going to be kind of particular to like the type of asset that's, you know, valuable and that will generate like a big estate tax bill. But for some reason you're not able to like, you know, go ahead and sell it or liquefy, create liquidity out of it. And so a couple of things here there is the opportunity to purchase survivor annuities and those tend to create that kind of liquidity so that the surviving spouse, you know, can continue to pay their expenses, etc. So that's something to Mention, if you're a business owner, you might be able to enter into buy sell agreements with your, your company or the other owners in order to generate, you know, some sort of liquidity, because there is the opportunity for the other owners or the company to basically redeem the decedent's interests in the business. So that can be an option. The other thing, let's just talk about.
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That one a little bit more because I think that one's super important. I think that's probably one of. I work with, I think like 80 business owner households. Like, that's most of who I work with. With, maybe two or three of them actually have this set up and funded correctly. They might have a buy sell agreement, but they most likely don't have insurance. And most people do not want the surviving spouse or their estate to come in and help run that business. But you don't really have a choice unless you actually set this up correctly. So it's funny, when we were thinking about this conversation, that is not one that I was actually thinking about, but I think it's extremely important there because one, it helps the family actually get the money that they deserve for the business. I think one point on this is you have to update your buy sell agreement because a lot of people, the first, they're like, I'm not really making real money in my business. There's no value. We'll set up the agreement, we won't fund it. Then a couple years later, they're like, okay, we're doing pretty well, let's fund it. And then five years later, it's like, you know, we're for 20% of the value of what that business would actually be. So you probably want to be revisiting that every couple years. But I think, again, that's a really good point on creating liquidity. And that's typically what's best for the business and the family.
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You.
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C
Yeah, along those same lines, you know, whenever you think buy sell, you can also think loans, right? And so this is actually applicable to all sorts of illiquid assets. So I had a client in private practice who was an artist, or rather, you know, she had been an artist. And so all of her net worth was tied up in art and her own art. And so when you think about, you know, something that's really difficult to sell and create liquidity for, you do not want to flood the market all of a sudden with one artist's works because you have to pay for the estate tax. And so that's the type of thing where a Farming business or something like that, where you're going to have a really hard time basically selling the asset or creating liquidity loans can kind of give you some leeway to continue keeping that asset within the family, but generate liquidity from it.
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It.
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And then I would say lastly, of course, is life insurance. We call, you know, life insurance this. It's the ultimate way to create liquidity. So I had a lot of clients who were in real estate, you know, big real estate landlords in New York City. They always had life insurance to. To create that liquidity. And so if there is already an estate tax that's being implicated, just know that the life insurance proceeds, unless they're protected within a mechanism and we can talk about that will itself become taxable as well. And so the most common way to sort of have the life insurance proceeds but also not increase the tax bill is to put it into an irrevocable life insurance trust. So that's the wrapper around the life insurance to make sure that it's still outside the taxable estate. Rachel, do you have anything to add on that?
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I mean, no, I would say that, you know, definitely getting the trust, having an eyelet and setting that up is important. But then also it's another layer of you get the insurance you put in the trust. You have to make sure that the beneficiaries and the provisions of that trust allow you to pay those expenses if they do come due.
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B
Yeah, and I think it's a good point because I think the first myth that most advisors, especially most insurance salesmen have is that, you know, life insurance is not taxable, but if it's just in your name, right. It gets added to what your taxable estate is, and that can lead to estate taxes. Right. So then the eyelid basically gives you the structure where, hey, it is protected from it. But it's not as simple, I think, as many people think, right? What is the amount of premiums? Like, how much are we putting in? Are we using yearly gifting? Are we going above it? Who are the beneficiaries? How this is structured correctly. But then on top of that, right, a lot of real estate investors like to have permanent life insurance because they like the borrowing power from it. These are two completely different strategies, right? You're not using your eyelet to fund more real estate purchases. You're using your eyelet to help pay estate taxes. And funny enough, I was talking about this on Twitter a little bit ago, and some advisors, like you just never know what the estate tax amount is going to be. And so this just makes no sense to have an eyelet. But I think the goal isn't to say like, oh, we're projecting you to be at 41.5 million. Here's your estate tax number. The permanent insurance is going to get to the dollar, correct. It's to directionally help you, right? So if it's going to be 4 million or 6 million, we don't know. But if you have 4 million, at least it helps you where you don't have to liquidate as much in other assets to kind of get to where you want. Because like you said, being a for seller is never where you want to go. Sure, you might, but most people don't say, hey, let me buy and accumulate all this real estate. Let me pass away and have all my kids go sell all my real estate. They're probably like, it's paid off, they're going to be covered, right? They can have a property manager get great cash flow and this is going to help them have a really great life. It wasn't. Maybe they thought, well, let's wait for the step up in basis and let you sell it. But I think generally they do want to keep it through their family, right?
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C
It's funny because I feel like eyelets are so polarizing. You can probably pull all these estate planners and I'm curious, Rachel, which end of the spectrum you fall on? But then there are some, you know, I worked with estate planners who are like, well, everyone should just, just automatically put their life insurance policy in an islet. Why not? You know, as long as you can administer the islet and you know, as an estate planner for your own family, you probably are like, yeah, easy peasy, you know, just have some crummy letters issued out, it's fine. You know, some people are just like, if the administration of the islet was easy, then everyone should just stick their permanent life insurance policies inside of one of these trusts. So, Rachel, I don't know if you have.
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I'm on the spectrum where I, I do not see a why you wouldn't do an eyelet. I do think islets are great. But to your point, I think Thomas, you mentioned this as well. You know, the administration of it. You just have to. Actually, it's not as simple as some people think. Like, it is simple as long as you follow the rules, you do the steps, you file the gift tax returns and you just keep track of the annual exclusions to make sure you're doing it all properly. Because there's nothing worse than whenever you Know, you get a new client, they had an eyelet that was previously set up, and then you have to go back and backtrack to figure out what happened.
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B
Yeah, yeah. And I think it really depends on the goal. Right. Like, I'm not a big believer in the use life insurance as a great place to borrow from because I think you have the same thing in your taxable brokerage account. Right. You can have liquidity there. You can borrow at low rates. Right. So I think if you think about this as, hey, I want liquidity at death pretty much always an eyelid does make sense if you're on the side of, I do like life insurance for borrowing power. I think maybe rethink your strategy there because I think there are better tools and ways to do it. But if that was your route, you probably wouldn't put an eyelet. But the term side is interesting. I think it's very rare to ever to see people put term in an eyelet. I know, Ann, we've talked about this and you said, you said you have seen people do it, but I've rarely seen it. Well, because most people, I think in this high net worth space, they have term for a little bit and then they're using term to then convert. And then you have to just think through, do we put it in eyelid at the term in the beginning for when we convert it, or what's the mechanism to get it? There's.
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C
I think that's right. I, I have had clients, but I think usually as a, almost like a secondary policy to a permanent life insurance policy. So, Rachel, what have you seen with term policies?
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I don't think I've ever seen a term in an islet.
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Yeah. Yeah, that's what I figured. Okay, cool. What have we not talked about about creating liquidity here? I think like most people understand, right, you get step up in basis on your taxable brokerage account. So if we need liquidity, that's a pretty good place to create it. You know, I think it's just this, the business side of things, right. Do you get a step up in basis based on that type of business? If not, do you have buy sell agreements? If not, then then what are you doing? Because that one would. That one in real estate is where things get really hard because especially your business, right? If you just lost a partner, probably not the best time to sell. If you haven't brought in somebody new to help kind of grow that business and you know, make it more sellable. Any other thoughts, things we've missed?
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C
No, I'D just be interested if our audience has ever had to, you know, come up with a solution to this problem. We'd love to hear from you. And yeah, now these are some of the more common strategies, I think. But not paying attention to liquidity, I think could get your clients into hot waters, especially at a time when things are tough for them from an emotional perspective. You know, Thomas, you mentioned the business as well. Well, you know, it's just. It's not a great time to all of a sudden be like, oh, I need to claw back assets from your loved ones, you know, because we didn't consider this issue.
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Yeah, I think there's a lot of room for advisors to help plan around it, but also the side of like, make sure they have a good estate plan in place, make sure trusts are set up, make sure beneficiary designations are correct. So if we have these issues where we're having to kind of raise funds, pay tax quickly, that it is, we have a smooth process to get there versus potentially waiting two to three years in California and scrambling to try to figure out what to do.
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C
Exactly. I think the bottom line, the bottom line, I would say, is just take a look at those beneficiary designations. With liquidity in mind, it is possible to overly create too many non probatable assets. So things that pass by operation of law and then consider what that play out for yourself and the client, what it would look like for them to pass away with a portfolio, have, and whether or not liquidity is something they should consider.
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B
Yeah, okay. Perfect. All right, well, Rachel, thanks for joining us. Glad to have you here. Now, moving forward for a bunch of episodes, everybody, we really hope you enjoyed this episode. If you guys have any thoughts or things that maybe we didn't mention that we should talk about in a different episode, let us know. But we'll see you back here in a couple weeks. It.