Life Insurance Premium Financing

Life insurance premium financing is not for everyone… but it may be for you

Simply put, life insurance premium financing is a strategy where instead of using their own capital to pay the premiums, policyholders borrow the cost of the initial life insurance premiums from a lender. With sufficient collateral for the loan, interest costs can be much more manageable than paying the policy premiums. Moreover, potential capital gains taxation can be avoided on assets with unrealized gains that might otherwise have to be liquidated to pay the premiums.

Life insurance premium financing has expanded in popularity in recent years and is now widespread among highly liquid clients with a general net worth of $5,000,000 and above. In certain cases, however, the strategy can yield excellent results for individuals with more modest assets who are highly liquid, i.e., who have a liquid net worth of approximately ten times the amount of contemplated annual premiums. Young professionals in particular can take advantage of lower premium rates based on good health and age, and allow their anticipated longevity to work over time for cash value and dividends to accumulate after repaying the loan.

The main purpose of life insurance premium financing is not to enhance the underlying performance of a portfolio of assets, but rather to maintain a substantial death benefit with minimal impact on the liquidity, or underlying asset structure of the client. Over time (10+ years), the cash value within the policy can become sufficient to pay back the loan principal or a large death benefit can pay off the loan while still leaving a substantial amount to distribute.

At some point your assets will be on their own

Like it or not, at some point your assets will have to operate without you. Most rational people feel a natural disinclination to pay 40% of their assets in estate tax vs. dispose of them as they see fit. But it’s complicated, and the world is full of cautionary tales of famous people who die with insufficient estate planning, and consequent enormous – and perhaps avoidable – estate tax bills.

Fortunately, as part of a well-designed estate plan, life insurance premium financing, when appropriate, can be a straightforward and effective tool. When executed adeptly, the purpose of the technique is to build up the death benefit over a long time, on an estate free basis, protecting the wealth you’ve worked your whole life to generate.

How does life insurance premium financing work?

Investors use this financing strategy to afford a maximized death benefit and fund the premium cost versus paying it on an annual basis from personal cash flow, or the liquidation of assets. Cash value begins to accrue in the policy from day one. Over time, the cash value can exceed the aggregate of premiums paid therefore allowing clients to cover future premium payments without reliance on outside assets or liquidity. Ultimately the goal is to have the cash value of the life insurance policy pay back the loan and provide a substantial death benefit to the policyholder’s heirs with significant tax advantages. While this is the goal, sometimes the best laid plans can go awry by failing to anticipate future developments in market conditions and interest rates! That’s why it is imperative that all of the client’s advisors, collectively plan these facilities and forecast the potential dynamics under a number of different scenarios.

This strategy has worked well in a steady, low interest rate environment but the math becomes trickier in rising interest rate environments like the one we are currently experiencing. When interest rates increase, policyholders will need to pay more interest on the loan even though its principal doesn’t change. Depending on how much the costs of this structure increase, the costs of financing in addition to the costs of the premium can exceed the cash value of the policy. This dynamic is often overlooked or minimized as part of the sales process but it is a very real possibility requiring the policyholder to commit additional outside assets to fund the financing costs and policy premiums. In certain cases, the bank can call a policyholder’s loan in which case other assets must be used to pay the loan back.

In situations where the loan matures but the underlying policy itself has not performed to the point where the cash value can pay it back, policyholders will want to access the secondary financing market for these types of policies, as well as a secondary purchasing market. (AKA, this strategy is not without its risks.)

A powerful tool for estate planning

Life insurance premium financing should be considered for its advantages over substantial time periods. A large death benefit can be a particularly effective strategy for estate planning. For higher net worth individuals, the policyholder can first create an irrevocable life insurance trust (ILIT) to hold the policy. Then, at date of death there is significant liquidity in the insurance policy, but the trust is outside of the estate and is not subject to estate tax.

For example, consider the family of a business owner who at death would have to pay the estate tax on the value of an illiquid business within 9 months. The business assets might have to be liquidated in a fire sale to cover the estate taxes. With the life insurance policy, however, the ILIT can buy the assets from the trust at a fair market value, and the estate can then pay its estate taxes. The beneficiaries of the ILIT would typically be the same individuals who are the beneficiaries of the other trusts and assets in the estate.

Timing matters, especially with life insurance premium financing

In many cases, for people with sufficient assets, liquidity and cash flow, the earlier an individual takes advantage of life insurance premium financing the more powerful a tool it can be.

A classic example is a policyholder who buys inexpensive term life insurance upon becoming a parent and to cover the needs of a family in the event of an untimely demise. But by the time that individual is in his 50s, term life insurance premiums can become egregiously high. In this situation, a more effective alternative might be to create a trust funded with a much larger premium financed whole, indexed universal life (IUL), or PPLI policy. In this way, the cash value allows the policyholder to engage in premium immediately and also have a high death benefit for heirs.

Independent, experienced advice is essential

Often this product is not driven by financial advisors but by insurance agents who are selling and structuring the policies and earning a commission on sales. An unfortunate, imprudent few sell buyers’ larger policies than the latter can comfortably afford out of the cash value accumulation or present unrealistic assumptions for IUL performance within the policies. If clients aren’t cautious, they may be hit with an unexpected and unwelcome annual capital call.

Fortunately, Fieldpoint offers trusted, objective advice, protecting clients from others with ulterior agendas and preventing very expensive mistakes with insurance premium financing given its many intricacies and complexity. It’s especially important to have a trusted advisor with a long-term view given the projected benefits of life insurance premium financing typically take as long as ten years to accrue.

Maintain a substantial death benefit without compromising your liquidity

Life insurance premium financing can be an excellent option for high net-worth individuals. But success of this strategy depends on combining a well-structured insurance policy with a well-structured loan facility necessitating close coordination among banking and insurance professionals, especially in conditions of rising interest rates that can negate many of the potential advantages of life insurance premium financing. But when structured correctly under the right conditions, individuals can leverage their balance sheet to capitalize the costs associated with a large death benefit, and add this strategy as a component of sophisticated estate planning. Let Fieldpoint be your guide to this potentially powerful opportunity.

About Fieldpoint Private

Fieldpoint Private is a boutique private banking firm established at the onset of the financial crisis by 31 individuals including former Chairmen and CEOs of some of the most well-known and successful financial and consumer firms in America. Their intent was not to craft a firm that would emulate the large, established institutions, but to serve as an alternative. Dedicated to meeting the comprehensive financial needs of highly successful individuals, families, businesses and institutions, Fieldpoint Private offers a powerful combination of private personal and commercial banking services directly and in partnership with our clients’ most trusted advisors. In 2021, Fieldpoint Private founded Fieldpoint Private Trust, increasing the breadth of capabilities available to serve our clients in both sole trustee and co-trustee capacity.

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Trust services offered through Fieldpoint Private Trust, LLC, a public trust company chartered in South Dakota by the South Dakota Division of Banking.