What is Premium Financing Life Insurance?
Premium financing of life insurance is a way for high-net-worth individuals (generally over the age of 50) to obtain the life insurance coverage they need without having to utilize other high yielding assets. Life insurance premium financing is a tool that an individual with substantial assets uses to cover the upfront costs and premium payments on a life insurance policy.
Why Choose Premium Financing?
Individuals often choose this course if they require a large amount of life insurance and do not want to pay the premium costs. Premium financing makes the most sense when an individual wishes not to liquidate high yielding assets to cover the premium costs of a life insurance plan. On the contrary, premium financing allows individuals to utilize their capital more efficiently. It also makes sense when the individual has a definite need for life insurance. Only when the need has been established should premium financing be evaluated as an option that may allow the individual to retain his/her assets or income for use elsewhere.
Premium financing is also viable when the interest rate on the premium loan is less than the insured could earn on the assets he would have liquidated to pay the premium, or when the interest rate on the loan is less than the policy is expected to earn. An individual may want to enter into a premium financing arrangement to obtain a lower out-of-pocket cost for a policy, to minimize gift tax concerns, and to keep from using cash flow or liquidating assets to pay insurance premiums.
While many programs are setup where the client must provide to the lender other “liquid” collateral for the loan besides the cash value life insurance policy, some programs can be structured using only the policy purchased as collateral. Collateral can include stocks and mutual funds, real estate equity, CD’s, etc. The life insurance policy is aggressively funded to build immediate and rapid-growth cash value, which is used to partially or totally satisfy the collateral requirements for the loan. Although some independent collateral may be required to initiate the loan process for the early policy years, eventually the cash value should become the sole source of collateral for the loan. At that point, outside collateral is released (typically around years 10 to 12).
Who Qualifies for Premium Financing?
Most premium financing policies require at least $2 million in net worth, and $100,000 a year in net income. The person insured under the life insurance policy has the option after 24 months to pay off the loan and maintain the insurance policy, or if needs change, they can even retire the policy in a life insurance settlement.
The goal of a well-structured premium financing program is to have the individual pay as little out-of-pocket as possible for life insurance, balanced against the risk that the interest rate of the loan will exceed the performance of the policy. In a typical premium financing arrangement, an individual applies for an insurance policy. Upon approval of the policy, the individual applies for a loan from one of four lenders or a lender of their own. Assuming the individual is both approved for insurance and qualifies financially, the policy is put in force and the financing is put in place.
Premium Financing Arrangements
- Borrowing Premium Only
The individual borrows only premiums, and the individual pays the interest.
- Borrowing Premium and Interest
The individual borrows premiums and the interest on the loan and has no annual outlay.
- Borrowing Some Premium and Interest
The individual borrows some premiums and/or some interest, usually for a period of time.
Premium Financing Exit Strategies
Premium loans can be repaid in four main ways:
- During life, from the borrower’s available assets.
- During life, from policy cash values (this is dependent on policy design at inception).
- At death, from policy proceeds (this usually happens automatically).
- Through sale of the policy as an asset, although never an intentional reason to do premium financing.
Income Tax & Gift Tax Considerations
- Interest on a loan to acquire a life policy is generally considered personal interest and is not deductible under IRC sections 163 and 264.
- Loans to a trust for premium payments are not taxable gifts.
- It is unlikely that the IRS would consider a personal guarantee on a loan to be a completed gift until a payment is made.
- Life insurance proceeds, although generally not subject to personal income tax, will be included in the insured’s estate if the insured owns the policy or has any incidents of ownership.
- Under Private Letter Ruling (PLR) 9809032, the IRS ruled that even though an irrevocable trust had borrowed funds from the insured to purchase a policy and the loan remained outstanding at death, the proceeds were not includable in the insured’s estate.
- Providing a personal guarantee on a loan should not cause incidence of ownership in the policy.
Health Insurance Specialists, Inc. (HISI) is dedicated to serving the investment needs of its clients.
With an exceptional team of insurance and financial planning professionals, HISI provides clients with the financial expertise to protect and grow their portfolio, and realize their long-term goals.
To learn more about premium financing, please contact the office at (301) 590-0006.