We are now at Step 2 of the 7-Step Estate Planning Framework. In this step, our focus is to review the assets that we have tabulated and to make sure that there will be sufficient liquidity in the estate to deal with short term and long term funding needs.
You can find all the steps here:
Step 1: Ensure Estate Surplus
Step 2: Ensure Estate Liquidity
Step 3: Plan Your Estate Wisely
Step 4: Write Your Will
Step 5: Register Your Will & Keep It Safely
Step 6: Consider Other Tools: Trusts, AMD, LPA & HOTA/MTERA
Step 7: Review Your Estate Plan
Liquidity is the fancy way of saying if there is enough cash to meet immediate needs. So when we talk about estate liquidity, what we mean is: Is there enough cash in the estate to take care of the immediate cash needs, like paying for funeral expenses, any outstanding medical bills not covered by existing medical insurances, ongoing monthly expenses etc.
Another important aspect of Liquidity is that when an asset is converted to cash, it retains most of its value. Consider this scenario: if you need to quickly sell off your investment property that has been valued at $1.5M, do you think you will get more or less than $1.5M? Due to the urgent nature of the sale, you would most likely have to accept the first offer that comes along resulting in having to let go of the property at depressed, fire-sale prices (possibly at $1M or even less). So we recognise that real estate is NOT a liquid asset.
In addition, the entire property transaction can easily take 3-6 months before you have access to the sale proceeds. So the next important criteria to consider when evaluating the liquidity of your estate is: how long it will take to access the funds. Typically, anything that takes less than 7 days as relatively liquid.
Therefore, the 2 key aspects of liquidity to consider when evaluating your estate are:
Some examples of illiquid assets that can be found in an estate are:
So how do you evaluate your estate's liquidity? I'm glad you asked. We will use 4 financial ratios to evaluate your current situation. These ratios are used as part of a financial health check (11 ratios altogether) when evaluating one's financial health. Here are the ratios we will use:
Let's look at these ratios one at a time and in more detail.
The objective of this ratio is to help us determine how many months our Cash Assets can last us in the event our primary income is disrupted.
Here are the components of this ratio:
Cash / Cash Equivalents
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Monthly Expenses
Cash / Cash Equivalents can consist of the following assets:
Typically, a healthy range is between 3-6 months. However, this number should be interpreted in the context of the kind of job you hold. If you are working in a very secure environment, like a civil servant, then you could get by with number on the lower end of the healthy range. But if your job is more volatile or there is less job certainty, then it will pay to be more conservative and put aside more cash for a rainy day.
In the context of estate liquidity, we will need to deduct Final Expenses from the numerator first. So, this is the number of months our loved ones can live on before the estate has been processed for probate or by administration and therefore will have access to the estate.
Cash / Cash Equivalents less (Final Expenses)
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Monthly Expenses
The objective of this ratio is to help us determine the additional months that your Liquid Assets can provide as a cash buffer beyond the Cash Liquidity Ratio.
Here are the components of the ratio:
Liquid Assets
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Monthly Expenses
Liquid Assets can consist of the following assets:
This ratio should be as high as possible.
As many people use their CPF Ordinary Account (OA) to service their home monthly mortgage payments, this ratio is typically overlooked in most financial health checks. The objective of this ratio is to determine how many months of mortgage payments can be paid from the remaining balance of your CPF-OA.
Here are the components of the ratio:
CPF-OA Balance
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Monthly CPF-OA Payments
Just like its cash equivalent, a ratio of 3-6 months is deemed to be healthy.
In the context of estate liquidity, your CPF monies will be paid to your nominated beneficiaries. So make sure you have a valid and updated nomination. More information here.
Finally, the last ratio measures the additional buffer (in months) you have in our CPF-OA account when you liquidate your CPF-OA investments
Here are the components of the ratio:
CPF-OA Balance Investments
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Monthly CPF-OA Payments
Again, the higher the ratio, the healthier you are in this aspect.
In the context of estate liquidity, CPF investments are not covered by your CPF nomination but will form part of your estate. More information here.
So, in summary, in this step, we are trying to make sure your loved ones have enough cash to meet their immediate financial needs in the event of your demise. This is done by evaluating your estate for its liquidity. Here are some immediate steps you can take to improve liquidity of your estate:
