Ultimate Guide to Premium Financing
What is Premium Financing for Life Insurance?
Premium financed life insurance refers to the option where a policy owner borrows premium monies from a 3rd party lender to finance a life insurance policy. Premium financed life insurance is an option for policy owners who require a substantial amount of life insurance with large premiums.
Through financing the premium payments, the policy owner frees up capital as the loan pays for the premiums, while the policy owner may pay the smaller interest on the loan. The balance of the loan is repaid through a portion of the death benefit of the policy with the remainder going to the policy’s beneficiaries.
- The reason high-net-worth individuals and some businesses choose premium financing is a matter of leverage and capital sustainability. Paying the out-of-pocket costs of premiums on a massive life insurance policy can tie up cash that may be better deployed elsewhere.
Through borrowing the capital to finance the life insurance policy from a lender, the policy owner retains the maximum amount of capital for the largest possible life insurance policy. In a low-interest rate environment, wealthy individuals may borrow at favorable interest rates which equates to keeping a large life insurance policy active for the price of a low-interest rate on the loan.
Premium is particularly suited for high-net-worth people with excellent credit who require large life insurance policies. While being middle-aged or younger and in good health can make the underwriting process smoother and bring down the premium price, premium financing for life insurance can still be viable for older insureds with some health issues due to the standing of their credit and collateral assets. Generally, premium financed life insurance is suitable for people with a net worth of at least 5 million dollars or for family trusts and successful businesses. The ideal candidates for premium financed life insurance are:
- High-net-worth individuals worth $5 million dollars or more
- Successful businesses wishing to leverage premium financed life insurance policies to facilitate future buy-sell agreements or create attractive executive benefits packages
- Family trusts that seek to reduce the tax burden associated with large estates
Essentially, premium financed life insurance policies are a collaboration between an individual, family trust, or business entity, a premium finance company, and a 3rd party lender such as a bank. Here are the basic steps involved in the process.
- An individual applies for a life insurance policy (typically an Indexed Universal Life policy or a Whole Life policy) through their trusted life insurance agent.
- Once approved for the policy, the individual works with the premium finance company to obtain a loan from a 3rd party lender that will cover the entire premium cost of the life insurance policy. This loan may be granted and distributed through a family trust. Additionally, the 3rd party lender will require collateral to administer the loan.
- Throughout the course of the premium finance loan, premiums are paid thru the Lender from the individual or the trust to the life insurance carrier.
- Throughout the course of the loan, interest payments may be paid by the borrower to the 3rd party lender. It is possible that the cash growth of the life insurance policy will cover the interest payments to the 3rd party lender.
- At the end of the loan term, the balance of the loan will be paid to the 3rd party lender from the death benefit of the life insurance policy. The remainder of the death benefit will be distributed to the beneficiaries (heirs, charities, etc) of the policy.
In the end, the individual was able to obtain a very large life insurance policy by predominantly using just enough capital to pay the interest on the loan. The lender is repaid through the death benefit, and the beneficiaries may receive the remainder of the death benefit tax-free.
There are some exceptions and notes on this process. For example, the term of the loan may not coincide with the length of the insurance policy. Typically, loans of this type will come due between 3 and 5 years. This requires the policy owner to refinance their policy and update the term of their loan. A host of factors can impact the interest rate on the new loan which may require more collateral or financing from the policy owner.
It is not unusual for the original loan to be used to maximize the cash premium payments into the policy during the first several years. In an Indexed Universal policy, this will allow the largest possible base amount for the policy to begin funding itself if the market index is favorable. In either event, maintaining a sound relationship with the lender and excellent credit can go a long way in ensuring favorable loan terms throughout the course of the policy.
There are many benefits for high net worth individuals and businesses when utilizing premium financed life insurance for tax and legacy planning purposes. Here are 5 key benefits that are made possible through premium financed life insurance.
- By paying the interest on the loan instead of the higher premium payments associated with large life insurance policies, the individual may be able to maximize their standard of living during their working years.
- A person maybe can maintain more of their liquid assets without liquidating their other assets. This allows for strategic deployment of more cash towards high-yielding investments that would otherwise be tied up in paying premiums on the insurance.
- Despite the payment of interest over the course of the loan, the front-loaded cash value of the policy has the potential to compound more cash into the policy should the market maintain favorable growth.
- The possibility to receive supplemental tax-exempt retirement distributions that are untouched by the individual’s high tax bracket.
- The ability to keep the death benefit separate from the overall estate tax allows for the individual to spend down assets that are less favorable from a tax and estate planning perspective.
Estate planning is a complex and integral part of efficient wealth management. Premium financed life insurance, when combined with astute estate planning can create tax-friendly opportunities for the legacy of the individual.
- Families whose assets are tied up in illiquid investments (such as property) can acquire the large insurance policy they need without selling their assets to cover the cost of high premiums.
- People in substandard health that would normally have difficulty obtaining large insurance policies can use their financial standing, credit, and leverage to obtain a sufficient policy and overcome the higher costs.
- The death benefit provides substantial, tax-free liquid assets that can help offset the tax burden of the estate itself. This allows the heirs of the individual the ability to maintain the estate without having to dissolve important, cash-generating assets.
Premium financed life insurance is not limited to protecting the legacy of an individual. More and more, businesses are realizing that they can use this same tool to protect their companies and their key personnel. Premium financed life insurance can help with:
- Buy-Sell Agreements
- Should one of the owners of a business pass away unexpectedly, the onus is on the remaining owners to come up with the capital to buy out the share of the deceased. This capital can drain a business of basic operational money and threaten the longevity of the business itself. Succession planning for business is complex and premium financed life insurance can simplify this process dramatically.
- Key Person Protection
- Losing a valuable employee can cost a business a small fortune in lost revenue and capital. Leveraging the favorable loan rates of a premium financed life insurance policy allows the business to move forward after this tragic event without losing precious capital.
- Executive Benefits
- Now more than ever, providing your high-net-worth employees with competitive benefits can make or break a company’s ability to acquire and retain top talent. In order to achieve this without spending capital that could benefit the business, a premium financed insurance policy checks both boxes while offering the most competitive benefits packages available. Additionally, the lower out-of-pocket costs to maintain these benefits will make the company’s balance sheet more attractive to investors and others who require a detail of the company’s financial health.
- Buy-Sell Agreements