By Boyce F. Lowery, CLU, ChFC
Did you know that you could possibly use other people’s money to buy your life insurance? That’s right, other people’s money. It’s called premium financing. Premium financing is when you or your business borrows money to pay for your life insurance premiums instead of paying the premiums with your own money. Further, your business could get a tax deduction for the interest paid presuming the expense is ordinary and necessary.
Who Does This and Why?
Premium financing is mostly used by individuals or businesses that want life insurance but have their money tied up and/or don’t want to liquidate other assets. It could be a business owner that wants to be able to invest all of the profits back into his business instead of withdrawing capital, which could hinder growth. A high net-worth individual might use premium financing so as not to reduce her current cash flow. Others have vast real estate holdings that they have no desire to liquidate just to pay for life insurance. Investors utilize this method as well so that they don’t have to cash out lucrative investments and pay the capital gains taxes.
Every situation is unique, but all viable situations for premium financing include a need for life insurance, whether for business planning, for meeting future tax obligations, for an asset diversification strategy or for maximizing the inheritance for heirs. Though they need the insurance, the participants don’t want to change their current assets, so they make use of premium financing. This can potentially lead to an increased internal rate of return for both the cash growth in the policy and the policy’s death benefit.
How to Qualify?
Corporations, trusts, partnerships and individuals that have a minimum net worth of $5,000,000 are generally eligible to apply for premium financing. Of course, the insured must be able to qualify medically for the life insurance policy.
Further, there must be an insurable need and a desire for permanent life insurance coverage. In general, the insured will have to be age 85 or younger. The policy owner or trust must have liquid assets to post for collateral when the policy values are insufficient to meet the collateral requirements. Alternatively, there must be an ability to obtain a letter of credit on non-liquid assets.
How Does Premium Financing Work?
Simply put, an individual or business purchasing a large life insurance policy secures bank financing with the borrowed funds to be used to pay the policy’s premium payments. Sometimes an individual will have an Irrevocable Life Insurance Trust (ILIT), and the policy owner and the insured will be a grantor of that trust. The policy owner will borrow a sum of money each year, typically over a period of 5 years or so, in order to fund the policy as quickly as possible. The policy owner is responsible for the loan and it is secured by policy cash values, the policy’s death benefit and any outside collateral that needs to be pledged. In most cases, the client should service the annual interest, which is usually set at a very competitive interest rate.
Provided that the cash value of the policy stays higher than the outstanding loan, the financial institution will be fully secured with many lenders. However, some lenders will only give credit for 95% or so of the policy’s cash value toward the required collateral amount. If the policy’s cash value and any previously provided collateral are insufficient to meet the required collateral amount, the policy owner will be required to provide the additional collateral. This collateral may be a letter of credit, investments such as mutual funds or stocks and bonds, or cash equivalents.
When the insured passes away, both the loan and any of the accumulated interest on that loan will be deducted from the policy’s death benefit and paid to the lender. The amount of remaining death benefit will then be passed on to the policy’s beneficiaries. Depending on the performance of the policy that was financed and other factors, it may be possible to retire the loan during the lifetime of the insured from policy cash values while maintaining the needed coverage with no further cash outlays.
Is Premium Financing Right for You?
There is an array of situations where premium financing makes good sense. However, it is not a way to obtain free life insurance. Like any other financial strategy, there are pros and cons you will want to fully understand. The question is, of course, is premium financing right for you? Call us toll free today at 888-827-0146, and we can discuss your situation and help you ascertain whether premium financing might be appropriate for your situation.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the managing partner of Suncrest Advisors, he, his partner, and their associates all aim to provide financial security and peace of mind to business owners, executives and professionals, and high net-worth individuals across the United States. Along with more than four decades of experience, Boyce is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit http://suncrestadvisors.com/ or connect with Boyce on LinkedIn.