Ultimate Guide to Premium Financing
What does it mean to use premium financing for a life insurance policy?
Individuals and families that require substantial life insurance and asset protection may choose a premium financed life insurance policy that frees up liquidity while still providing significant policy benefits.
Through borrowing monies from a lender to finance an insurance policy, the policyholder may be able to secure a larger policy while paying the Lender a simple (and possibly lower) interest rate on a loan. The loan covers the policy premiums and the policyholder may pay the interest on the loan.
At the end of the loan term, the policyholder can repay the balance of the loan or structure a new loan with the lender. Loan repayment can also occur if the insured person passes away, by making use of a portion of the death benefit.
High-net-worth individuals can require a substantial amount of life insurance to adequately cover their estate. The premiums on a high-value life insurance policy require large cash payments. Cash paid toward the premiums could be better used in other investments and assets. Additionally, an individual may want to avoid having to liquidate assets in order to pay the premium.
In a low-interest-rate environment, however, wealthy individuals can borrow money at more favorable rates allowing them to borrow the cash for the policy premiums while possibly paying only the interest on the loan. This frees up liquid capital for alternative investments and uses.
The ideal candidate for premium financed life insurance is an individual who:
- Has a net worth to support the loan through the life of the loan
- Has excellent credit
- Has the need for a very large life insurance death benefit
Generally, good health is also an advantage when it comes to premium rates, however, individuals with health challenges may be able to secure a premium financed insurance policy if they meet and exceed other criteria.
A family trust can also be established as the benefactor of a premium financed insurance policy. This may greatly ease the burden of estate taxes once the insured passes away.
Additionally, a candidate could also be a successful business that wants to take advantage of premium financing in order to facilitate buy-sell agreements or add competitive benefits packages for their key personnel.
The process toward obtaining a premium financed life insurance policy involves 3 entities: The individual (may also be a family trust or business entity), a life insurance company, and a lender.
- The individual applies for a life insurance policy such as Indexed Universal or Whole Life insurance policy through their insurance agent.
- If the individual is approved for the policy, they then work in coordination with a premium finance company to secure a loan from a lender to cover the premium cost of the policy. Collateral will be required by the lender to complete the loan process.
- With the policy and loan in place, premiums are paid by the lender to the insurance carrier.
- The interest from the loan may be paid by the individual to the lender. In some cases, it might be possible that cash accumulated in the policy can be used to pay the interest on the loan.
- At the end of the loan term, the balance of the loan can be paid to the 3rd party lender from the cash surrender value of the life insurance policy. The remainder of the death benefit will be distributed to the beneficiaries (heirs, charities, etc) of the policy.
There are some considerations to take into account when obtaining a premium financed life insurance policy. For instance, the length of the policy may be greater than the term of the loan. A premium financed loan may come due between 3 and 5 years requiring the policy owner to refinance the policy and renew or update the loan at the end of the term.
The original loan is often used to increase cash premium payments in order to maximize the cash growth potential of the policy, especially during the first several years of the policy. In an Indexed Universal policy, for example, this will allow the largest possible base amount for the policy to begin funding itself if the market index is favorable.
For tax and legacy considerations, high net worth individuals enjoy many benefits from a finely tuned, premium financed life insurance loan. Here are 5 key benefits to consider:
- Enhance your standard of living
- In leveraging the loan to pay the high insurance premiums, the individual may be able to retain cash to spend on life events and other investment instruments.
- There is the possibility to receive supplemental tax-exempt retirement distributions with a life insurance policy that is outside of the individual’s tax bracket.
- Cash flow and liquidity for the individual are retained by spending cash only on the smaller interest payment to the lender.
- The cash value of the policy can be loaded in the front end of the policy, allowing for a faster accumulation of compounded cash in the policy.
- Since the death benefit itself is not taxable to the estate, the individual may be free to spend down other assets to maximize their overall estate plan.
- Enhance your standard of living
Estate planning is an essential component of effective wealth management. Taxes to large estates can have deleterious effects on families after the primary breadwinner passes away. Premium financed life insurance can act as a hedge against some of the more onerous taxes placed on large estates. If a family has many assets that are tied up in illiquid investments such as large land and property holdings, the death benefit from a life insurance policy can ensure that the family may not have to liquidate holdings in order to pay the estate tax.
The tax-free, liquid asset of the death benefit itself on a life insurance policy can help maintain the estate without dissolving lucrative assets or taking away from investments that the beneficiaries will rely on for generations to come.
Beyond securing policies for individuals, premium financed life insurance can be an excellent tool for successful businesses to retain capital while offering competitive benefits and advantages to the business. Premium financed life insurance is an excellent tool for:
- Facilitating Buy-Sell Agreements
- When a business is confronted with the loss of a key stakeholder, the ability of the remaining owners to buy out the shares of the deceased can be burdensome. Precious capital needed to maintain the integrity of the business can be compromised if it must be used to complete the buyout. Premium financed life insurance simplifies this succession process and frees up the capital needed to continue operations.
- Key Person Protection
- The revenue lost when a key employee passes away can be disastrous for a business. A well-planned, premium financed life insurance policy may allow the business to leverage low interest rates in order to shore up cash and help the company move forward to finding a qualified replacement.
- Executive Benefits for Key People
- Acquiring and retaining top talent is essential to any competitive business. Today, key personnel look for attractive benefits packages as part of their decision to join a company. Owners are faced with the challenge of offering highly competitive packages to keep talent in-house without draining working capital that the business needs to thrive. A carefully planned premium financed policy may provide the benefits necessary without risking the company’s balance sheet.
- Facilitating Buy-Sell Agreements