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 (usually an irrevocable life insurance trust – ILIT), with the death benefits earmarked for use by the 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 their pockets, there are other options – premium financing, in particular, provides substantial potential benefits over self-funded premiums.
Pros and Cons of Financing Life Insurance Premiums
Financing the premiums of a life insurance policy can offer numerous benefits including:
- The opportunity for HNW individuals to retain control over more of their own funds. This enables those funds to be put to use for other productive purposes/investments.
- Using borrowed funds to substantially magnify buying power and reduce the time necessary to build significant cash value in an insurance policy.
- The potential to greatly alter the degree and timing of gift tax liability, depending upon the structure of the loan arrangement and the particulars of policy and rate performance.
While life insurance premium financing is very often a sound strategy, there are some potential shortcomings that should be kept in mind.
- As with any financial vehicle, life insurance policies have the risk of poor performance.
- Changes in tax rules (gift tax, AFR tax, etc.)
- Interest rates can change, sometimes significantly, in short periods of time
- Depending upon policy performance and interest rates, substantial additional collateral may be required from the borrower.
The Typical Life Insurance Premium Financing Arrangement
Once the decision has been made to use premium financing, what does a “normal” arrangement look like? Life insurance premium financing for HNW individuals is a relatively straightforward arrangement.
The typical steps are:
- The HNW individual creates an ILIT
- The ILIT engages a reputable lender such as Global Financial Distributors to borrow the funds necessary to pay the premiums on a life insurance policy
- The ILIT uses the borrowed funds to pay the premiums on the policy according to the payment structure outlined by the carrier.
- The ILIT makes annual payments to the lender (often simple interest, but can be structured as a fully or partially amortizing loan).
- Collateral for the loan is made up in part by the cash value of the policy and, to the extent cash value is insufficient to meet the loan payoff obligation, by other, qualified collateral posted by the borrower.
- At the end of the loan term, the borrower can either: payoff the initial principal from outside funds, payoff the loan principal by withdrawing cash from the policy, or opt to extend the loan term with the borrower. (Note: here are other available “exit strategies” for a life insurance premium financing loan as well – please consult GFD’s marketing library for more in-depth examination of the options for ending the loan arrangement.)
Structuring and funding financial strategies for high net worth individuals is a highly specific and customized process. With so many options available for the financial planning professional to choose from in crafting a plan for their high net worth clients, life insurance is frequently one of the best options available to meet broad range of client requirements. By choosing to finance their premiums, HNW individuals may be able to take advantage of a significant range of benefits as compared to using their own funds to pay for policy premiums.
The GFD team can provide as little or as much support as our financial planning affiliates require. Our approach is custom-designed to meet the needs of the planner and the client. For more information about life insurance premium financing, please contact us today.