What is considered even and fair when it comes to estate planning and the distribution of wealth across family members? Our Business & Family Solutions team at Lighthouse Canton provides an overview of the difference between ‘Equal’ and ‘Equitable’ distribution, the different ways estate equalization can be carried out and the benefits of the right succession planning strategy.
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Wealth distribution between one’s children is always a sensitive topic for any parent, especially when it comes to handing over a self-made or multi-generation business and invested assets that are illiquid in nature. Not to mention the decisions on which asset to distribute to which family member. Estate Equalization means creation of equitable distribution of a family’s assets between family members. ‘Equitable distribution’ is quite different to ‘Equal distribution’. “Equal” means that everyone will be given the same amount or opportunity. “Equitable,” in modern parlance, is a way of dividing things more fairly.
Why is this relevant?
Most parents struggle with the idea of ensuring that the wealth distribution they make is fair and that all their children are happy and live in harmony once this wealth has been distributed. Traditionally parents used to just divide the existing assets between the family members. Over a period of seeing several litigations, it was realized that this was not the most optimal way, especially in cases where businesses and illiquid assets were involved.
We have all heard the quote “shirt sleeves to shirt sleeves in 3 generations” and this has been true for so many families that have not planned correctly thus facing the risk of wealth being dissolved because of disputes over inheritances following the passing of the parent.
This is especially true when not all family members are actively involved in the business. It is therefore important that each child feels they have been treated fairly by their parents and do not create an issue as the family moves forward. It is because of this that the concept of Estate Equalization was born, whereby the parent creates a new asset altogether to give to the children that are not involved in the family business as opposed to just dividing the said business assets between all the children.
For a family, maintaining harmony and peace between members is more important than having their children fighting over which sibling got which asset.
Estate equalization thereby has a huge relevance when it comes to planning and determining business succession. The strategy involves advance planning by the business owner / parent to facilitate an equitable transfer of assets in a fair manner amongst his beneficiaries.
‘Equal' vs ‘Equitable’ wealth distribution
Traditionally and even to date, some families believe that doing an equal distribution to each of the children is fair. However, equal distribution has still caused a lot of friction between siblings where
- one child was left with a cash rich business worth $50 million which was generating revenue and increasing value on a year-on-year basis, had the opportunity to earn salary, bonus and employee stock in the company; and
- the other child who received real estate worth $50 million, which was illiquid and not generating yield close to the business revenue and extremely difficult to dispose of.
In the above case, the latter sibling sued the former sibling for a share in the business profits citing that the original intent of the parent was to ensure that both children have equal assets and income from the estate.
It is considering the above that more and more families are now moving towards the concept of equitable distribution as opposed to equal distribution.
Tools used for Estate Equalization
Life Insurance has been used as a very successful planning tool in achieving equitable distribution. In this approach, the parent takes out an insurance policy on his name. The coverage amount is equivalent to what the parent believes will be the future value of his business on a particular date. The beneficiaries of this policy can be changed depending on which of the children decide to get into the family business as opposed to those who steer clear of it. Policies like these can also be supplemented with other policies depending on the changing family circumstances or the value of the businesses increasing exponentially.
This approach ensures that each beneﬁciary receives an amount equal to the future estimated value of the business as share of inheritance (i.e., the family business or family assets as applicable).
The biggest advantage the parent sees is that instead of dividing the existing assets between the heirs, the parent created a new asset altogether for the heirs who have no interest in the existing business or such other assets.
The Benefits are as follows:
- Provides liquidity and financial security for beneﬁciaries not interested in the family business, thus not requiring the business to be liquidated
- Maintains trust and conﬁdence amongst siblings by preventing family dispute over inheritance
- Effectively increases/ doubles the wealth that can be distributed among heirs
- Business succession planning between members who are interested in the business and long-term value-creation
- Long term value creation, continuity, and growth without business disruption
What is of importance is that a business owner realizes the need for this strategy early on while he is young, rather than later when health issues or advanced age don’t allow him to acquire a policy of that value.
The right succession planning strategy can spell success for any family in every way where the family continues to stay together harmoniously through generations. It also inculcates the same values in the children who one day will become parents themselves and possibly apply the same strategy their parents did for equitable wealth distribution.
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