Premium Financing

Life insurance is a key component of a financial planning strategy for most high-net-worth (HNW”) individuals. Generally, a policy is held inside of a trust, with the death benefits earmarked for use by the estate for the benefit of the HNW individual’s spouse, children, or other designated beneficiaries.

Such arrangements offer HNW individuals numerous benefits, particularly when planning for significant estate tax liabilities or for supplemental retirement income needs. While some HNW individuals will opt to pay the life insurance premiums out of pocket, there are other options – premium financing, in particular, can provide substantial potential benefits over the self-funded approach.

  • The opportunity for HNW individuals to retain control over more of their funds. These funds can then be put to better use such as investments or injecting additional capital into a business.
  • Using borrowed funds to magnify buying power and reduce the time necessary to build significant cash value in an insurance policy.
  • The potential to direct the degree and timing of gift tax liability, depending upon the structure of the loan arrangement and the particulars of policy and rate performance.
  • Policies have the risk of poor performance.
  • Changes in tax rules (gift tax, AFR tax, etc.).
  • Interest rates can increase, sometimes significantly, in short periods of time.
  • Depending upon policy performance and interest rates, substantial additional collateral may be required from the borrower.

Once the decision has been made to use life insurance premium financing, what does a “normal” arrangement look like? Life insurance premium financing for HNW individuals is a relatively straightforward arrangement and the typical steps are:

  1. The HNW individual creates an insurance trust (“Trust”).
  2. The Trust borrows the funds necessary to pay the premiums for the life insurance policy.
  3. The Trust uses the borrowed funds to pay the premiums on the policy according to the payment schedule outlined by the carrier.
  4. The Trust makes interest payments to the lender.
  5. Collateral for the loan is made up of the cash value of the policy and, to the extent cash value is insufficient, other agreed-upon collateral.
  6. At loan maturity, the borrower can either, a) pay off the principal with outside funds; b) pay off the loan principal by withdrawing cash from the policy; c) extend the loan term with the borrower. (Note: there are other available “exit strategies” for a life insurance premium financing loan as well – please work with your financial planner to learn more about the options available).