By Dick Aubrey
Consider the value of a vacation home owned by a woman we’ll call Mrs. Jones. Her husband had died years ago and her daughter’s family was the only ones to use the substantial cottage in Michigan, which had been in their family for decades, as a regular vacation spot.
The daughter’s husband was a teacher, which gave the family the whole summer to enjoy the cottage in what had become a high-priced area of Michigan. Unfortunately, teachers don’t have a lot of money. Neither did Mrs. Jones, who lived comfortably on a couple of pensions.
When Mrs. Jones died, there was a problem. A huge problem. Her other child, a son, lived in Florida and had no interest in ever coming north of Waycross, Georgia ever again in his life, and so the vacation home was useless to him.
It happened to be, as well, about ninety percent of Mrs. Jones’ estate, and it was very big.
The son, as was completely his due, wanted his half of the estate. The daughter and her family were not in a position, by several hundred thousand dollars, to buy him out. Nor were they in a position to start an installment plan to him at any rate that would pass the laugh test. Nor were they in a position to even take out a mortgage to fund his half. What little liquidity Mrs. Jones had left didn’t make a dent in the obligation.
The only solution was to sell the place. But was an immediate sale what Mrs. Jones really had in mind upon her death, and did any of the family members really want to see it go?
This is what I refer to as “indivisible”. It’s not a pile of currency that can be weighed out and divided into as many piles as there are children. The only solution was to sell it and that ruined it. Half of a place like that doesn’t exist.
The solution, of course, would have been life insurance. Mrs. Jones, by the time I found out what was going on, was beyond being insurable, and at her age the premium would have been far too high. She needed to have foreseen this and planned for it thirty years earlier. Hers is not a special case and when the indivisible that must be divided is a business, such as a water dealer, the unforeseen results can be even more disconcerting.
Dividing assets equitably
Any asset, be it a summer home or a small business, that has two simple characteristics presents exactly the same problem. The first is that it is the majority of the estate. If you plan to leave it to your children, the degree of difficulty rises with the number of children you have. If it is half of your estate and the other half is liquid and you have two children, you’re pretty close to being okay. If you have three children, though, the math gets trickier. The other characteristic is that it cannot be divided into equal parts to satisfy all the planned beneficiaries without substantial loss. Mrs. Jones’ place could not be divided without destroying its value to the family.
If you have a business that amounts to 80 percent of your estate, and you have two children, one of whom wants to follow in your footsteps and install RO systems, while the other wants to be a special education teacher, you have a problem. The business could take on substantial and possibly crippling additional obligations to make heavy payments to buy out the uninvolved sibling. Or the special education teacher is given half a share in it and doesn’t work at it, but merely gets half the profits. If that isn’t a stage for conflict of interests, let alone a little sibling rivalry, I can’t imagine one.
Selling the business in order to split its value will destroy its use to the family member who wants to keep it. He or she would have a chunk of money worth half the business, and no business. Any other attempt would be a matter of half-measures that might work, or might work on paper, or might not. And when it doesn’t work, the potential for bad blood is ripe.
Preserving the indivisible
If you do the math and discover that your estate consists of one indivisible asset worth 80 percent of the total, and the rest is liquid, do you have to purchase so much life insurance that each of two children can have equal amounts without destroying the indivisible asset? No. You only need to purchase enough that the arrangements can be managed without creating hardship. If the child who is not interested in the indivisible asset gets, say, half of his or her share immediately, the opportunity to make manageable arrangements about the balance is increased by an order of magnitude.
The solution will vary, but for most purposes, the best type of life insurance policy is called, survivorship or second-to-die. In this type of policy, two people, generally husband and wife, are insured and the policy pays off when the second of the two dies. Since the asset will probably not be passed to the next generation until then, a second-to-die policy would probably work.
Second-to-die policies, not paying until the second of two people pass on, are surprisingly economical. The insurer can look forward to a statistically long period before having to pay the death claim.
What the premium will actually be for a given amount of insurance depends on several factors. Age counts. In addition, the underwriting process will be the final judge. Underwriting consists primarily of evaluating your health situation in terms of life expectancy. You’ll fill out an application, which includes health questions. The company will write to your doctors both for general information and additional details about specific questions which surface in the application or the examination.
Even if you otherwise would qualify for the company’s absolute best rate—not a high probability in any case—you could be ineligible if your parents or siblings have health issues. The companies aren’t doing genetic testing, but statistics show that heart problems, cancer or early onset diabetes in a parent is a telltale sign that we are susceptible. With all these factors in mind, take the example of a couple, both aged 50, both underwritten at a standard rate for $100,000. The annual premium would be in the neighborhood of $1600.
Is preventing a catastrophic division of the indivisible worth a couple of these?
The contract used is a universal life plan. Various factors within the policy, such as the interest rate credited, can affect performance. I’ve picked a premium, which will guarantee the coverage at worst-case rates. Whatever the policy does better than worst-case is extra. It might allow you to reduce premiums at some point. But, however well or poorly the policy performs, it is guaranteed to last to age ninety-five.
So, what’s the downside? The downside is that in some cases, by the time the estate is due to be passed on, the indivisible doesn’t have to be divided anyway. You purchase insurance now to guarantee that your dealership will be passed on to you daughter who wants to enter the business and there will still be enough money for your son to get his fair share, but by the time you pass, you’ve gone out of business or sold it to a competitor. What then? Well, then you have a couple hundred thousand dollars in the estate with no place to go but to the beneficiaries.
That saves the potential trouble of having to divide the indivisible and leaves more money in the estate than expected. That probably won’t strike many beneficiaries as a problem.
About the author
Richard A. Aubrey CLU has been in the life insurance business for more than 30 years. His interest is in individual insurance, both life insurance and disability income coverage. A graduate of Michigan State University, Aubrey is at Piper McCredie Agency, Inc., and can be reached at [email protected].