Premium Finance
What is Premium Financing?
Premium financing is an exclusive life insurance option for people with a net worth exceeding $5 million. The are few exceptions to any individual or couple with a net worth under that benchmark. Premium financing with an irrevocable life insurance trust separates the value of your life insurance from your estate. As such, it is not subject to estate taxes.
Premium financing for life insurance sets up an irrevocable life insurance trust that removes the life insurance proceeds from the value of your estate. The trust takes out a loan through a 3rd party lender that works with the life insurance company to pay for those premiums.
The life insurance company gets paid from the loan to the trust. The bank gets paid through gifts to the trust, then entirely repaid with a portion of the death benefits. Your beneficiaries get immediate, tax-free cash upon your death.
It is not quite that simple in practice. Working with an estate lawyer to set up the trust, a life insurance agent for the insurance and loan portion, and a trusted financial planner are all key to setting this up correctly.
Why Premium Financing?
One of the most cost-effective ways for high-net-worth individuals to protect their assets and create estate liquidity is to take advantage of premium financing for life insurance.
The problem is that high-net-worth individuals require large life insurance policies. These can become extraordinarily costly. While paying the premiums may not be an issue, you may need to liquidate assets to cover the premiums.
Premium financing for life insurance avoids incurring capital gains tax and liquidating investments to cover these life insurance premiums.
A life insurance policy is a hedge against future risk. Its primary purpose (for high-net-worth people) is to maintain liquidity and security for your estate.
Specifically, high-net-worth people use it for at least one of the following reasons:
- Protect their business(es)
- Wealth transfer/inheritance issues
- Mitigating state and federal taxes
The proceeds of a life insurance policy provide immediate tax-free liquidity to your beneficiaries. Your beneficiaries can use the cash proceeds from a policy to cover any estate issues or expenses. They won’t have to wait for other assets from the state to become available, preserving the estate’s assets.
Life insurance is a financial tool for high-net-worth families. It’s not the same type of expense as a middle or working-class family would consider it.
Typically, the IRS factors life insurance proceeds into the sum of your estate. This can present a problem with federal and estate taxes. If your estate exceeds $11.2 million for an individual or $22.4 million for a couple, these taxes apply to your estate.
Premium financing of life insurance is a simple financial strategy to separate your life insurance benefits from the total of your estate.
How Does Premium Financing Work?
Certain life insurance companies created specific products exclusively for premium financing of life insurance policies. These plans are designed to minimize third-party collateral and maximize returns.
The purpose of the premium financing loan is so that you do not need to liquidate any assets to pay the life insurance premiums.
If you were to pay for the premiums, you run the risk of paying capital gains tax or lowering your ROI on your remaining investments. This runs the risk of diminishing your overall net worth.
Keep in mind that individual life insurance premiums are not tax deductible. The IRS considers life insurance premiums to be a personal expense.
Simply put, you use the premium financing loan to pay for life insurance premiums. Like any loan, you pay interest on the loan (and some of the principal if you structure it that way).
When you pass away, the benefits from your life insurance policy first repay any remaining balance on the loan. Some people choose to pay only the interest on the loan and have the death benefit pay off the rest. Other people prefer to pay down both the interest and principal. This is why an estate planner and financial advisor can be of use when setting up premium financing.
The steps are as follows:
- Develop a preliminary life insurance and financing strategy with your life insurance agent, financial planners, and financial management group.
- Choose the best custom premium financing plan for your needs.
- Initiate life insurance carrier underwriting.
- Initiate formal bank loan application.
Another trick to minimize premiums long-term is to add a return of premium rider on your policy. It can add to the initial cost, but the life insurance company will return all premiums paid. This is an easy way to pay off the bank loan.
Also, if you are married, considering a second-to-die policy can save money.
Finding a Premium Financing Company
The loan process for premium financing is different from more traditional loans. It is not just a simple matter of contacting the baking institution you use already. Our premium financing team already has relationships in place with banks that will approve loans for this strategy.
Premium financing loans require tailoring to the specific needs of each client. Loan commitments will vary on a case-by-case basis so that both you and the bank can reach a beneficial arrangement.
Structuring your loan properly allows you to:
- Align your long-term need for permanent life insurance
- Determine a sustainable long-term financing strategy
Ideally, the best scenario is obtaining a premium financing arrangement using a long-term loan that involves a variable or fixed interest rate. This interest rate should be tried to the London Interbank Offered Rate (LIBOR) or some other index.
The best tactic for financing an IUL policy is to fund it over the first seven to ten years at the maximum level. Doing this allows the policy to grow a cash value quickly and on a tax-deferred basis. This financing plan management strategy permits the life insurance policy to be fully collateralized.
You also need to be careful in how you fund the policy in the first ten years. If you fund it too fast, you can impact the endowment contract status.
The overall strategy should be structured to build up enough cash accumulation which you can then borrow against to pay off the loan. Because the money is technically the life insurance proceeds, it is not taxable.
It’s also vital to keep in mind that you must not borrow more against the policy than you have paid in premiums. Any amount you borrow that is greater than the total premiums paid will become taxable.
Finally, have an exit strategy in place. Most experts suggest a 10-15 year exit strategy. Review it annually so you or your financial advisor can make appropriate adjustments.
Collateral Requirements for Premium Financing
Typically, every lender requires that every borrower be able to secure the premium financing loan with collateral. The life insurance policy secures the loan, but lenders still need collateral protection.
Generally, they accept collateral liquidity such as:
- Cash or cash equivalent
- Letters of Credit
- Other existing life insurance policies
- Marketable securities (50% discount for stocks)
Most lenders will also consider other cash values to use as a source of collateral.
In ideal circumstances, the cash value of the policy will provide all (or a substantial portion) of the necessary collateral for the loan.
How Our Premium Financing Specialists Can Help
At USA Investment Solutions we have premium financing experts standing by to help answer any questions you have about the process. We are an independent life insurance brokerage with access to over 90 of the top-rated life insurance companies in the country, including top-rated companies offering premium financing appropriate policies.
Because we specialize in meeting the needs of high net worth individuals, we provide not only individual life insurance policies but also a variety of business life insurance services such as buy/sell agreements and key man life insurance. We already have relationships with the banks that are best for premium financing cases.
Additionally, because not everyone has the good fortune of perfect health, we focus on helping people with pre-existing medical conditions find life insurance at the lowest prices possible.
Give us a call anytime at (949) 620-2888. We are here to answer your questions, and there is never any obligation to buy.