Most savvy investors are familiar with the concept of life insurance and the many uses it has in terms of both business and individual financial planning. One concept that may not be well known – at least not yet – is that of life insurance premium financing.
Premium financing has become a very up and coming topic in the life insurance world. This technique allows high net worth individuals the ability to obtain a life insurance policy without the need to pay for it up front.
This way of structuring life insurance policy premiums allows those who have a substantial net worth to cover the cost of a large life insurance policy without, in most cases, the need to yield any of their own assets in order to pay the policy’s premium.
How Does Life Insurance Premium Financing Work?
In essence, an individual purchasing a large life insurance policy – with a minimum death benefit in the millions of dollars – has a bank or other type of financial institution loan them the funds that are needed to pay the policy’s premium.
With the concept of premium financing, a life insurance policy holder will borrow a sum of money each year – typically for a set time period – and then puts those funds towards a cash value life insurance policy.
The policy holder is responsible for the loan, and as long as the cash value of the life insurance policy stays at a certain set amount, then the policy holder will not be required to pay any interest on that loan.
In this case, provided that the cash value of the policy stays high, the financial institution that has loaned the funds will be protected. However, should the amount of the life insurance policy’s cash value dip below a certain amount, then the policy holder will be required to make payments on the loan.
There are some instances when the premium loan may require additional liquid collateral. This collateral may be investments such as mutual funds or stocks, however regardless of what the collateral consists of, it must be callable.
Due to the collateral requirement from clients in posting their liquid wealth, the lender essentially has access to these assets to the extent that the lender may be allowed to convert these investments to cash should it be needed for policy premium payment. Candidates for this type of life insurance strategy, then, should be aware of this requirement.
When the insured passes away, both the loan and any of the accumulated interest on that loan will be deducted from the policy’s death benefit and paid to the lender. The amount of remaining death benefit will then be passed on to the policy holder’s beneficiaries.
Business Uses of Life Insurance Premium Financing
By investing in a corporate owned permanent life insurance policy, business owners may be able to fund a current income for themselves as well as retain any surplus funds inside of their company – while also allowing the funds within their life insurance policy to grow on a tax deferred basis.
Business owners can use premium financing as a way to have access to a tax deferred investment vehicle while also having tax free use of the funds if needed. These individuals find that by using life insurance premium financing, they can not only take advantage of tax deferred growth on the cash value build up inside the plan, but also have a set amount of life insurance protection for their loved ones in the future.
Those who are a partner or owner of a business may also be able to use life insurance in this way in order to cover the loss of key employees or to fund a corporate buy sell agreement, which essentially may help to protect their company upon the death of the owner or other key executives.
By using premium financing on a permanent life insurance policy, business owners have the flexibility to access the protection, the security of tax deferred investments, and the liquidity that is needed in the corporate environment. In addition, the funds can also typically be used for personal benefit as well.
Who Is A Good Candidate for Life Insurance Premium Financing?
Many of those who are candidates for life insurance premium financing will usually need to have a minimum net worth of $2 million and be earning an income of at least $100,000 per year. The insured policy holder will typically have the option to pay off the premium loan after two years of owning the policy. At this time, the policy holder may decide to end the policy by selling it via a life settlement, or they may opt to continue the coverage by paying off the policy premium loan.
These policies tend to work best for policy holders who have a longer term need for insurance coverage. Those who have the ability, however, to sustain the requirements of the recourse loan and to assign a minimum amount of collateral for the purpose of securing that loan are good candidates for such a planning technique.
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