Estate planning professionals spend a great deal of time trying to project the estate taxes that may be due and devising strategies to lower the eventual tax burden.

This is understandable. Very large estates with a net value in excess of $5,340,000 face the federal estate tax, with a top tax rate of 40%. And some states impose steep taxes. In Washington State, for instance, each estate with a net value in excess of $2 million faces a top rate of 20%.

But, often overlooked in the process of seeking to minimize the tax burden is an analysis of how estate taxes will be paid. As a result, a simple solution for addressing estate liquidity needs – life insurance – may be missed.


Estate taxes are generally required to be paid within nine months of death in cash. Extensions can be requested for “reasonable cause.” But an executor must convince the IRS that the estate is eligible for the extension. Additionally, he or she must pay taxes to the extent possible and demonstrate a reasonable effort to convert assets to cash.

An extension may also be available if the value of a closely held business interest exceeds 35% of the value of the adjusted gross estate and the decedent was a U.S. citizen who owned more than 20% of the business. The executor can elect to pay the federal estate tax attributable to the business interest over two or more annual installments. However, estate taxes attributable to the other assets in the estate must still be paid by the prescribed due dates and the IRS is likely to require a surety bond or a special lien on the business interest. Finally, the IRS will accelerate all remaining installment payments if the estate fails to make any installment or if any portion of the business is distributed, sold, exchanged or otherwise disposed of, or 50% or more of the value of the business interest is withdrawn from the business in money or property. Clearly, this can get complicated.

Relying on extensions to pay estate taxes that are due should not be part of a thoughtful estate planning process. The result could be liquidation of assets in a short window of time – in other words, a “fire sale.”


To avoid liquidating assets after death, individuals whose estate is expected to be taxable should regularly conduct a liquidity needs analysis with their advisors. If the analysis identifies a potential shortfall, life insurance policies can be considered. Generally, this entails projecting the amount of estate taxes that may be due based on reasonable assumptions about the growth rate of the estate, changes in tax rates, life expectancy and future lifetime transfers of assets, and then identifying potential sources of cash that will be available to pay the projected taxes.

Life insurance is one of the best alternatives for addressing any shortfall in estate liquidity needs. Not only does it provide necessary cash at the exact time it is needed, it is very tax efficient. If a life insurance policy is structured properly, death benefits are not subject to either income taxes or estate taxes. Also, the proceeds of the policy can be used to purchase assets from the estate, leaving the estate with the necessary cash and the intended beneficiaries with the assets.

There are a number of lifetime benefits that can be realized by funding liquidity needs with life insurance. In light of current federal income tax rates and the 3.8% tax on net investment, the tax savings offered by life insurance can be significant. Also, if there is a need for cash, the cash value of a policy can be accessed during life through tax-free withdrawals and loans. Last, if the estate liquidity needs are addressed in other ways – like through sale of a business interest or lifetime gifting programs – the cash value of the policy can be used for other purposes, such as retirement income.

Planning for liquidity is a critical step in the estate planning process. Taxpayers and their advisors should not ignore life insurance in analyzing the options.

John Meisenbach is the founder and CEO of Seattle-based MCM, a leading independent benefits consulting and insurance brokerage firm.

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