A Tool to Pay Life Insurance Premiums
- People who need substantial life insurance coverage for estate
or business planning are often faced with a dilemma: Does it make
sense to (or do they want to) use current cash flow or liquidate
investments to pay the premiums? Premium financing may offer high-net-worth
individuals the ability to borrow the premiums to pay for an insurance
policy, allowing them the use of funds they might have otherwise
used to pay for the insurance.
financing makes most sense when the individual has a definite
need for insurance. Only when the need has been determined should
premium financing be evaluated as an option that may allow the
individual to retain his assets or income for use elsewhere. This
should not be proposed as a “free” way to obtain life
also makes sense when the interest rate on the 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.
for most programs are $2.5 million in net worth and $200,000 a
year income. The borrower must also be a bankrupt-remote entity
(i.e., creditors cannot attach the individual’s assets for
bankruptcy), such as an LLC or an irrevocable life insurance trust.
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. At the same time, the individual applies for a loan from
a lender, usually arranged by the insurance company. While the
individual is being medically underwritten for the insurance policy,
he is also being financially underwritten for the loan. Assuming
the individual passes both tests, the policy is put in force and
the financing is put in place.
Financing Due Diligence
should consider the following questions before entering into any
premium financing arrangement:
spread over the loan interest rate must the policy earn? Generally,
the policy will have to produce returns of 150 to 300 basis
points over the loan interest rate. The loan will usually be
based on LIBOR. Lower performance runs the risk that there will
not be enough cash in the policy to collateralize the loan.
is the loan commitment fee?
- How long
is the loan renewable for? Is it a term loan for a short period
of time? Or is it a loan that extends well past life expectancy?
- Is a personal
guarantee required for the loan, or is it backed by the insurance
life insurance product works best in a financing arrangement?
Universal life and whole life generally will not be able to
provide the necessary returns to make a premium financing arrangement
work. Variable life could work, but SEC margin requirements
make this a high-risk venture. This leaves equity-indexed life
as the product that gives the policyholder the best chance to
outperform the loan.
- Is the
program designed to be based on life expectancy, or is it conventional?
Life-expectancy programs assume that the insured dies at his
IRS-calculated life expectancy. If he lives beyond that, the
loan amount will start to exceed the cash value and the program
are the basic types of financing arrangements.
premium only. The individual borrows only premiums, and the
individual pays the interest. If the policy is owned by an irrevocable
life insurance trust, then the interest is considered a gift.
premium and interest. The individual borrows premiums and the
interest on the loan and has no annual outlay. Policy design
is key, because the policy must earn more than the interest
rate; otherwise it will either lapse or require a substantial
payment by the policyholder.
some premium and interest. The individual borrows some premiums
or some interest, usually for a period of time.
Financing Exit Strategies
can be repaid in three main ways:
life, from the borrower’s available assets.
life, from policy cash values (this generally requires the lender’s
approval if the lender is the assignee).
- At death,
from policy proceeds (this usually happens automatically).
Tax and Gift Tax Considerations
on a loan to acquire a life policy is generally considered personal
interest and is not deductible under IRC sections 163 and 264.
to a trust for premium payments are not taxable gifts.
- It is
unlikely that the IRS would consider a personal guarantee on
a loan-completed gift until a payment is made.
insurance proceeds will be included in the insured’s estate
if the insured owns the policy or has any incidents of ownership.
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.
a personal guarantee on a loan should not cause incidents of
ownership in the policy.
Tuttle, CFP, MBA, helps accounting firms develop wealth
management platforms. He is the author of Financial Secrets of My
Wealthy Grandparents (iUniverse, Inc., 2006). He can be reached
at 203-564-1956 or email@example.com.
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