Liquidity Strategies to Pay Estate Costs Without Selling Core Assets

Why liquidity matters during estate settlement

When someone dies, an estate often faces cash demands quickly: federal and state estate or inheritance taxes (when applicable), final income taxes, creditor claims, appraisals, probate costs and regular maintenance or payroll for a family business. Without advance planning, executors may feel forced to sell closely held properties or business interests at an inopportune time to pay these obligations.

In my 15 years as a financial planner working with business owners and families preserving multigenerational assets, the common thread in difficult settlements is a lack of ready cash. That’s avoidable with a mix of liquidity planning tools designed to meet short-term cash needs while preserving long‑term value.

(For background on related legal structures, see our guide to Life Insurance Riders and Trust Structures for Estate Planning and our Estate Planning Checklist for Business Owners.)

Common liquidity strategies — how they work and when to use them

Below are practical strategies I use in client plans, with pros, cons and execution notes.

1) Life insurance and irrevocable life insurance trusts (ILITs)

• How it works: A life insurance policy owned outside the insured’s taxable estate can provide an immediate, tax-free death benefit to pay estate costs. An ILIT owns the policy and keeps proceeds out of the estate for federal estate tax purposes when properly structured.
• When to use: Estates with significant illiquid assets (business interests, real estate) and potential estate tax exposure, or where heirs lack ready cash.
• Pros: Immediate cash at death; can be sized to cover expected taxes and settlement costs.
• Cons: Premium cost; if the decedent owned the policy at death it may be includible in the estate. Proper drafting and funding needed (see our ILIT guide above).
• Authority: IRS guidance on inclusion of life insurance in gross estate and estate tax rules: irs.gov.

2) Short-term borrowing: estate lines of credit / asset‑based loans

• How it works: The estate or executor borrows against estate assets (business collateral, investment portfolio, or real estate) to pay urgent expenses and taxes, repaying the loan later from insurance proceeds, sale proceeds, or ongoing business cash flow.
• When to use: When you need liquidity quickly and expect reliable repayment sources in months to a few years.
• Pros: Preserves ownership and avoids fire‑sales; interest may be tax-deductible to the extent allowed.
• Cons: Requires qualifying collateral and underwriting; interest cost; mismanagement risks if repayment plans fail.
• Professional tip: Negotiate terms that allow interest-only and flexible prepayment to match estate timing.

3) Installment sales, deferred payment or seller financing

• How it works: Beneficiaries or outside buyers acquire estate assets via installment sale or vendor financing, spreading cash receipts over time and often keeping the asset in family hands.
• When to use: For business interests or real estate where the buyer (family or third party) can operate the asset and prefers gradual purchase.
• Pros: Preserves operations; may smooth tax recognition with installment sale rules.
• Cons: Buyer credit risk; valuation and documentation critical; estate may remain exposed to creditor claims until fully paid.
• Tax note: Installment sale reporting has specific IRS rules—consult a tax adviser on interest, basis, and reporting.

4) Trust structures and earmarked cash reserves

• How it works: Revocable or irrevocable trusts can hold liquid assets earmarked for administration expenses and taxes, or direct distributions timed to pay costs.
• When to use: As part of an integrated estate plan; trusts can be funded during life to build liquidity for anticipated settlement costs.
• Pros: Controls distribution timing; can exclude assets from probate; protects assets from certain claims.
• Cons: Irrevocable trusts limit flexibility; funding and trustee selection matter.

5) Pre-funded reserve accounts and escrow arrangements

• How it works: During life, a testator funds a dedicated account or escrow that the executor can access immediately for settlement costs.
• When to use: For clients who want minimal complexity—useful for estates unlikely to trigger federal estate tax but still facing administrative costs.
• Pros: Immediate availability; low cost and easy to document.
• Cons: Funds removed from other uses during life; may not cover large tax bills.

6) Asset restructuring and portfolio liquidity management

• How it works: Shift portions of a portfolio into more liquid holdings (cash, short-term bonds) decades earlier or as part of mid-life rebalancing.
• When to use: Long-term planning for those anticipating large illiquid estates.
• Pros: Reduces need for reactive measures at death; supports smoother transition for heirs.
• Cons: Potentially lower long-term returns; requires tradeoffs between growth and liquidity.

7) Spousal and family loan arrangements (interfamily financing)

• How it works: Family members or trusts make loans to the estate or heirs under documented promissory notes or seller financing to avoid third‑party liquidation.
• When to use: When family has liquidity and is willing to fund purchase or bridge costs.
• Pros: Flexibility and potential tax planning; preserves family control.
• Cons: Can strain relationships; need clear underwriting and documentation.

Real-world examples (anonymized, representative)

• Example A: A family business worth $1.2M faced $180k in taxes and settlement costs. We obtained a 12-month line of credit secured by business equity and used a pre-funded term life policy payout to retire the debt six months later—avoiding a forced sale and preserving management continuity.
• Example B: A homeowner with a $900k estate (mostly primary residence) wanted to keep the home in the family. The plan established a funded revocable trust and a modest life insurance policy sized to cover typical probate and tax exposures, plus a contingency personal loan agreement with an adult child. The result: the home passed intact and settlement costs were paid from earmarked funds.

Practical implementation checklist for executors and planners

• Inventory liquidity: list cash, marketable securities, life insurance, lines of credit, and income-producing assets.
• Estimate likely obligations: tax filings, probate fees, creditor timelines, business payroll, maintenance and insurance.
• Prioritize immediate sources: cash accounts, insurance proceeds (if payable quickly), lender options.
• Document borrowing authority: confirm executor/trustee power to borrow; lenders will require evidence.
• Communicate with beneficiaries: set expectations and timelines; document any family loans or seller financing.
• Coordinate with tax and legal counsel: file timely estate tax returns (if required) and request extensions when appropriate.
• Preserve records: keep appraisal, valuation and transaction documents for estate tax and audit support.

Estimated settlement costs (guidelines, not guarantees)

Note: These are illustrative ranges. Estate tax exposure depends on exemptions, credits and elected deductions; state laws and rates differ.

Key tax and legal considerations

• Estate tax exemption and rates: Federal exemption levels have changed over time and may change again; many estates are not subject to federal estate tax but could still owe state estate or inheritance tax. Always confirm current thresholds on irs.gov.
• Ownership matters: Proceeds of life insurance are generally includible in the estate if the decedent owned the policy at death. An ILIT can prevent inclusion when properly established and transferred well before death.
• Basis step-up: Keeping assets in family hands may preserve a step-up in basis for capital gains purposes at death; conversely, installment sales and certain trust arrangements can change tax timing and basis rules.
• Loans vs. gifts: Interfamily loans must be documented and treated at arm’s length for tax purposes to avoid gift reclassification.

Common mistakes and how to avoid them

• Failing to fund the plan: Establishing an ILIT but not funding it or buying the policy defeats the purpose.
• Last-minute reliance on sales: Waiting until probate forces rushed asset sales at depressed prices.
• Poor documentation: Informal family agreements without promissory notes or clear repayment terms create disputes and tax risk.
• Ignoring state tax rules: Estate and inheritance taxes at the state level often bite when federal rules do not.

FAQs (concise answers)

Q: Can life insurance always solve liquidity needs?
A: It’s a powerful tool but must be properly owned and timed. A policy owned by the decedent may be includible in the estate; an ILIT is a common fix.

Q: Are estate loans taxable?
A: Loans themselves are not taxable income, but interest and security terms and the manner of repayment have tax and estate implications. Consult a tax pro.

Q: How quickly can an estate get cash?
A: Timeframes vary: insurance proceeds can be available within weeks if claim documentation is complete; loans depend on lender underwriting; probate asset sales can take months.

Action steps for readers

1. Build an estate liquidity worksheet now: estimate taxes, fees and 6–12 months of operating cash for businesses.
2. Review life insurance ownership and consider an ILIT if estate inclusion is a concern.
3. Talk to your estate attorney and CPA about pre-approved borrowing options and documented family financing.
4. Keep beneficiaries informed and name successor managers for privately held assets.

Professional disclaimer

This article is for educational purposes and does not constitute tax, legal or investment advice. Every estate is unique; consult a qualified estate attorney, tax advisor and financial planner to build and execute a liquidity strategy tailored to your situation.

Sources and further reading

• Internal Revenue Service (estate tax rules and life insurance guidance): irs.gov
• Consumer Financial Protection Bureau (estate planning resources overview): consumerfinance.gov
• See FinHelp guides: Life Insurance Riders and Trust Structures for Estate Planning, Estate Planning Checklist for Business Owners, and Valuing Private Company Interests for Gifting and Estate Planning.