PREMIUM FINANCING FOR LIFE INSURANCE: AN OVERVIEW

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WHAT IS IT?

Premium financing for life insurance is a term many have heard before, but aren’t quite sure how the strategy works or the clients that can benefit from it.  It is typically used as an estate planning strategy where borrowed funds are used to pay the premiums on large life insurance policies, sometimes in the millions.   Premium financing for life insurance is a strategy used by a qualified borrower to pay premiums instead of liquidating investments or using personal funds. 

In an estate planning strategy, the irrevocable life insurance trust borrows the funds to pay the premiums on the cash value life insurance policy and the grantor (insured) provides a letter of credit or collateral to the lender to insure repayment of the loan.  The goal is that over time, typically years after the policy’s inception, the cash value will be enough to take over the premium loan repayments on the policy. Additionally, at the grantor’s (insured’s) death the proceeds from the policy will pay any remaining debt to the lender and the balance will be paid to the beneficiaries of the trust.

HOW DOES IT WORK?

Most premium financing for life insurance is used for estate planning purposes, however, there are times it is used for alternative strategies such as tax-free retirement income for very high-income earners.  Still, despite the reason behind the strategy to use premium financing for life insurance, the route to implementing it usually follows the comparable 4 steps:

  1. Determining the insured’s financial suitability and insurance need
  2. Choosing the type of insurance policy, death benefit amount and interest rates to be used
  3. Formal application for both the insurance and loan with collateral to be used to secure the loan
  4. Policy delivery and ownership titling (generally in the name of the Irrevocable Life Insurance Trust)

An easier way to see all the participants in a premium financing for life insurance strategy and its moving parts is via the simplified graph below.

WHY USE IT?

One of the main reasons a client would utilize premium financing for life insurance is the ability to have a death benefit in place and still maintain assets that would otherwise have to be used to cover the premiums.  This strategy is used by clients who can afford the required premiums, but utilize leverage arbitrage to borrow funds with a low or no out-of-pocket cost.  The strategy allows clients to maintain their cash or illiquid investments with the expectations they will grow over the premium paying phase of the policy.  The interest rate environment also plays a big role in when to implement this strategy.  Low interest rates with a growing market and economy is a good environment to implement this plan.  Additionally, the client can possibly purchase more life insurance than they would if they were using their own dollars to pay for it.  The client can also take advantage of the crediting interest on the life insurance policy with the goal it outperforms the borrowing costs.  Lastly, the strategy may assist the client in eliminating or reducing their estate and gift taxes.

WHICH CLIENTS ARE BEST SUITED?

The average size of a life insurance policy for premium financing is greater than ten million dollars, with most case sizes being larger.  The ideal client for a premium financing for life insurance would be qualified and have a net worth greater than five million, although most favorable clients have wealth in excess of twenty million.  Most of the clients include, but are not limited to the titles of physician, business owner, hedge fund manager, real estate investor, corporate executive and professional athlete or entertainer.

RISKS AND THINGS TO LOOK OUT FOR

Premium financing for life insurance is a great option, but it does come with some risks and clients should be well aware of what they are before agreeing to this strategy.  There are four main areas a client should consider when deciding to finance their life insurance policy:

  1. Conditions of the loan and interest rate being charged by lender
  2. Type of cash value policy being used: Indexed Universal Life, Variable Universal Life or Whole Life
  3. Projected interest rate and cash value forecast of the policy
  4. Back-up plan if policy under performs the forecasts

CONCLUSION

Premium financing for life insurance has potentially great benefits to clients.  If the projected rate of return on the financed policy outperforms the loan’s interest rate being charged, the plan would be a valuable addition to the client’s portfolio.  Premium financing for life insurance does carry some risks and it is complicated.  A qualified client should be well informed of the benefits and risks associated with the strategy.  Therefore, it is imperative to consult with an insurance, legal and tax expert when designing and executing this strategy.   We are licensed and designated life insurance experts and will simplify the many options to help you decide what is best for you.  Call us at 800-674-3072 or complete our request a quote form and we’ll be happy to assist you.

About Liz Pace.

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