Premium Finance for Life Insurance: A Guide for High-Net-Worth Individuals
As a high-net-worth individual, you understand the importance of protecting your assets and securing your financial future. Life insurance is a crucial component of any comprehensive wealth management strategy, providing financial security for your loved ones in the event of your passing. However, the cost of life insurance premiums can be substantial, especially for those with expansive estates. That’s where premium finance for life insurance comes in.
Understanding Premium Finance for Life Insurance
Premium finance for life insurance is a strategic approach that allows policyholders to borrow funds from a third-party lender to pay for their life insurance premiums. This strategy is particularly beneficial for high-net-worth individuals who require large amounts of life insurance coverage but prefer to keep their capital invested in other ventures. By leveraging borrowed funds, policyholders can allocate their money to potentially higher-yielding investments, aiming to generate substantial returns that can be used to repay the loan.
With premium finance, a lender makes the premium payments on behalf of the policyholder, with the understanding that the policyholder will repay the borrowed amount along with interest at a later date. In some cases, but not all, policyholders may need to provide collateral to secure the loan, ensuring that the lender has recourse in the event of default. If the insured passes away before the loan is fully repaid, a portion of the death benefit is used to satisfy the outstanding loan balance, with the remaining amount paid to the beneficiaries.
Who Benefits from Premium Finance?
Premium finance for life insurance is most suitable for high-net-worth individuals with significant assets, typically exceeding $20 million. These individuals may have a need for substantial life insurance coverage but prefer not to liquidate their assets to pay the premiums outright. By utilizing premium finance, they can retain their capital for other investments that may offer higher returns than the cost of borrowing.
Advantages of Premium Finance
1. Tax Savings
One of the key benefits of premium finance for life insurance is its potential to minimize estate and gift taxes. High-net-worth individuals often face substantial tax liabilities upon passing their wealth to the next generation. By using premium finance, policyholders can free up their capital to address these tax obligations while still maintaining the desired level of life insurance coverage.
2. Leverage
Premium finance allows policyholders to leverage their existing assets and the cash surrender value of their life insurance policies to obtain the coverage they need today while deferring the cost of premiums to a later date. This strategy enables policyholders to make their money work harder by investing in other ventures that may offer higher returns than the interest rate on the premium finance loan.
Assessing Eligibility for Premium Finance
While premium finance can offer attractive benefits, not all individuals are eligible for this strategy. Lenders have specific criteria that potential borrowers must meet to qualify for premium financing. Here are some factors that lenders typically consider:
1. High-Net-Worth Status
To be eligible for premium finance, individuals need to demonstrate a high-net-worth status, typically defined as having $1 million or more in liquid assets. Liquid assets include cash, stocks, bonds, and other readily marketable securities that can be used as collateral or to repay the loan.
2. Age and Health
While age is not a strict disqualifying factor, lenders generally prefer policyholders who are younger than 70 and in good health. Younger individuals are more likely to qualify for longer loan terms, providing them with additional time to generate returns on their investments to repay the loan.
3. Significant Premiums
Premium finance is most suitable for individuals with substantial life insurance premiums. Lenders typically require minimum premium amounts to justify the cost and complexity of the financing arrangement. The exact threshold varies among lenders, but premiums in the range of $100,000 or more per year are typical. But who really wants to pay premiums of that size out of their own pocket? Most premium financed life insurance plans allow for up to 95% of the premiums to be covered by the lender.
4. Collateral Availability
Collateral is a crucial component of premium finance. Lenders require borrowers to provide collateral that can be used to secure the loan. This collateral can include cash, marketable securities, or the cash value of existing life insurance policies. The availability and quality of collateral play a significant role in determining eligibility for premium finance. In many modern designs, the cash value acts as 100% of the collateral so you never have to worry about covering the collateral shortfall with more traditional designs. While the more conservative deigns reduce the risks associated with this type of planning, they also can reduce the benefits. Ask your professional for several illustrations so you can compare and contrast the risks and the benefits of different flavors of planning. One size doesn’t fit all.
5. Professional Guidance
Given the complexity of premium finance arrangements, it is essential to seek advice from a qualified financial advisor or legal professional who specializes in this area. These professionals can assess the viability of premium finance for your specific circumstances and guide you through the entire process.
6. Ability to Repay the Loan
While the death benefit of a life insurance policy is often used to repay the premium finance loan, lenders typically require borrowers to demonstrate an alternative means of loan repayment. This ensures that the loan can be repaid even if the death benefit falls short due to unforeseen circumstances.
Risks Associated with Premium Finance
While premium finance can be an effective strategy for high-net-worth individuals, it is not without risks. It is crucial to consider the potential pitfalls and weigh them against the benefits before proceeding with premium financing. Here are some risks associated with premium finance:
1. Interest Rate Risk
Premium finance loans often have variable interest rates that can fluctuate based on market conditions. Rising interest rates can increase the cost of borrowing, potentially eroding the returns on investments and making the loan less attractive. It is crucial to carefully assess the potential impact of interest rate changes on the affordability and profitability of the premium finance arrangement.
2. Policy Performance
The performance of the underlying life insurance policy is another critical factor to consider. If the policy fails to generate the projected returns, the policyholder may face challenges in repaying the loan. It is essential to carefully evaluate the policy’s historical performance and assess the potential risks associated with policy underperformance.
3. Collateral Risk
Collateral plays a significant role in premium finance arrangements. Fluctuations in the value of collateral assets, such as marketable securities, can impact the loan-to-value ratio and trigger additional collateral requirements. It is essential to monitor the performance of the collateral and be prepared to provide additional collateral if necessary to maintain the loan. If this risk appears to be too big for your comfort level, it may make sense to evaluate a plan that doesn’t require additional collateral. Plans can be customized for anyone with a more conservative outlook.
4. Financial Sustainability
Premium finance loans typically have a limited term, often three to five years. At the end of this term, the loan may need to be renewed or refinanced. The lender assesses the borrower’s financial status and collateral at each renewal, which may result in changes to the loan terms or even the denial of renewal. It is crucial to ensure ongoing financial sustainability to meet the requirements for loan renewal.
Conclusion
Premium finance for life insurance offers high-net-worth individuals a strategic approach to manage their life insurance premiums while freeing up capital for other investments. By leveraging borrowed funds, policyholders can potentially achieve higher returns and minimize estate taxes. However, it is essential to assess eligibility criteria, understand the risks involved, and seek professional guidance to determine if premium finance is the right strategy for your specific circumstances. With careful planning and ongoing monitoring, premium finance can be a valuable tool in your wealth management arsenal.
Disclaimer: This article is for informational purposes only and should not be construed as financial or legal advice. Please consult with a qualified financial advisor or legal professional before making any decisions regarding premium finance for life insurance. Call us for a free evaluation to see if you qualify and attain a free illustration with all of the different type of programs available.
Premium Financed Life Insurance: A Solution for Frustrated Policyholders
Premium Financed Life Insurance: Solution for Frustrated Long Term Policyholders
Premium financed life insurance has emerged as a viable option for policyholders, offering a way to improve policy performance and potentially save on out-of-pocket expenses. In a challenging environment of falling interest rates, many life insurance companies struggle to meet the expectations of their policyholders, leading to reduced dividend rates and impaired policy performance. This article explores the concept of premium financing, its benefits, and potential risks, providing insights for policyholders considering this option.
The Challenge of Falling Interest Rates
For decades, falling interest rates have posed challenges for life insurance companies, making it difficult for them to achieve targeted investment returns on policy blocks. As a result, dividend rates have declined significantly, impacting policy performance. Whole life policyholders, for example, have witnessed a decline in dividend rates from a peak of 11.5% in 1989 to as low as 4.25% in recent years[^1][^2]. This decline in dividends puts policyholders in a dilemma, forcing them to make tough choices:
Pay more to sustain their policy benefits as planned.
Keep paying planned premiums and reduce the death benefit.
Allow the policy to lapse.
In some cases, even tax-free exchanges for new policies cannot compensate for the performance shortfall[^1].
Case Study: Jane’s Policy Restructuring
Image Source: FreeImages
To illustrate the potential benefits of premium financing, let’s consider the case of Jane, a policyholder disappointed with the performance of her policies. Jane, 55 years old, wanted to free up more cash flow for investment opportunities and reduce her annual premium expense of $68,980. Her three policies had a combined death benefit of $10,903,000 and a cash surrender value of $1,599,000. Without any action, Jane could expect the death benefit to remain around $10,800,000 at her life expectancy plus five years[^2].
Exploring Policy Exchange Options
One option for Jane was to roll or exchange her policies into a newer product design with a lower cost structure. Since her policies had no encumbrances and were beyond the surrender penalty period, she could use the $1,599,000 cash value to fund a new policy. After considering multiple choices, a protection indexed universal life (PIUL) policy seemed to offer the best outcome. However, the resulting death benefit of $7,794,000 meant sacrificing $3.02M in coverage. Given concerns over increasing estate tax exposure, Jane decided against this option[^2].
The Premium Finance Option
Premium financing presents an alternative solution for policyholders seeking to improve policy performance while maintaining flexibility in their cash flow. This option allows policyholders to obtain third-party financing to pay life insurance premiums, reducing initial and ongoing cash outflows. By utilizing premium financing, policyholders can keep their capital invested in higher-yielding assets without having to liquidate those assets to cover policy costs[^2].
Advantages of Premium Financing
Premium financing offers several advantages for policyholders like Jane:
Improved Death Benefit: By accessing premium financing, policyholders can potentially increase their death benefit, providing greater financial protection for their beneficiaries.
Enhanced Cash Value: Premium financing may also contribute to the growth of the policy’s cash value, increasing its overall value over time.
Increased Investment Opportunities: With premium financing, policyholders can redirect their cash flow towards higher-yielding investments, taking advantage of external investment opportunities.
Flexibility in Cash Flow: Premium financing allows policyholders to maintain flexibility in their cash flow, ensuring that they can meet other financial obligations while keeping their life insurance policies in force.
How Premium Financing Works
In a typical premium financing scenario, a policyholder secures third-party financing to cover life insurance premiums, minimizing their initial and ongoing out-of-pocket expenses. This approach enables policyholders to leverage their outside investment opportunities, projected to yield higher returns than their life insurance policies. By redirecting their annual cash flow towards these investments, policyholders can potentially achieve better overall financial outcomes[^2].
To understand the mechanics of premium financing, let’s revisit Jane’s case study. After favorable medical underwriting, Jane opted for an IUL policy with an initial death benefit of $18,010,390. The funding for the new policy involved two components: the carried-over $1,599,000 in cash value from her existing policies and an additional $997,947 financed by a bank specializing in premium financing[^2].
Jane projected that she would be able to repay the loan and accumulated interest using the policy’s cash values within 15 to 20 years. In the event of her passing before this time, the death benefit would first be used to repay the outstanding loan, with the remaining balance going to her beneficiaries. The new policy’s death benefit was designed to increase over time, projecting a net death benefit of $22,900,000 for Jane’s beneficiaries at age 89[^2].
Risks and Considerations
While premium financing offers potential benefits, it is essential for policyholders to carefully consider the risks involved before proceeding with this option. These risks generally fall into three main categories:
Lending Risks
Lending risks primarily relate to the interest rates and terms associated with the loans. Changes in loan duration or repayment terms can impact the desirability of a premium financing loan. Policyholders should assess the stability of the lending institution and evaluate the potential impact of interest rate fluctuations on their premium financing arrangement. But there are many lenders out there, so you ever had an issue with one lender, another can be found quickly. From the banks perspective, this is secure loans which contributes to their Tier 1 assets. These loans to fund life insurance premiums are highly desirable to the lenders and the regulators that oversee them.
Personal Risks
Personal risks are closely tied to an individual’s net worth, liquidity, and posted collateral. Factors such as a significant decrease in net worth or inadequate collateral can make it challenging to secure future premium loans or result in the lender calling in the outstanding loan. Policyholders should carefully evaluate their financial position and collateral requirements before entering into a premium financing agreement.
Policy Risks
Policy risks involve changes to the performance of the life insurance policy itself. While a policy can perform better than expected, there is also the possibility of it failing to meet expectations in terms of its crediting rate or dividend payments. Insurance companies may adjust insurance costs to meet profitability targets, requiring policyholders to pay additional premiums to maintain the policy’s intended performance[^2].
Conclusion
Premium financed life insurance offers an avenue for policyholders to enhance their policy performance while maintaining flexibility in their cash flow. By leveraging third-party financing, policyholders can potentially increase their death benefit, grow their policy’s cash value, and take advantage of external investment opportunities. However, it is crucial for policyholders to carefully assess the risks associated with premium financing and consider their specific financial circumstances before committing to this option. Consulting with a licensed professional can provide valuable guidance tailored to individual situations, ensuring informed decision-making[^2].
Disclaimer: The information provided in this article is for informational purposes only and should not be considered investment, tax, or financial advice. Policyholders should consult with a licensed professional to receive advice specific to their situation. Contact us to get a custom quote and illustration at 508-429-0011. No cost or obligation to see how the numbers work out. New rules restrict overly optimistic illustrations.
Section 79 plans may not be the wisest decision even though many small business owners would like to benefit from the 20-40% tax deduction salesmen are touting. We look at why the Section 79 gives lesser returns than other retirement plans and thus even with the tax deduction, they don’t make good financial sense. The following article discusses the disadvantages to using a Section 79 Plan.
Section 79 and Life Insurance Planning
Definition of Section 79 Plan: The Section 79 plans can be used by small business owners for asset protection and tax deductions. The plan will allow the owner to receive between 20% and 40% for a business deduction. This deduction will be applicable if the business owner purchases a CLV, also known as a cash value life insurance policy, and this policy must be individually owned.
When hearing what a Section 79 Plan is, many business owners may be eager to jump onboard and get one of these plans for asset protection and tax minimization if they are not sold in full disclosure. Since this is a tax-deductible way of getting a cash value life insurance policy, it sounds appealing. By itself, the cash value life insurance is a great retirement plan, but business owners should take a step back before making any hasty decisions and take a close look at the financial numbers. This will reveal that the Section 79 plans may not be as great as they first sound for asset protection and tax minimization.
Less than 10 Employees? Use Group Underwriting
If a business owner has 10 employees or less, laws restrict eligibility for any policy that has full medical underwriting. Instead, group underwriting will be required. Many insurance companies do not like group underwriting because these policies are more of a risk. When the math is revealed you will understand the reason these plans should be avoided for asset protection and tax minimization.
Section 79 Plans Disadvantages
The reason the Section 79 plans are so marginal is because the insurance policy that is being purchased, by nature and inheritance, is set up poorly to get the full deduction. In other words, the types of cash value life insurance policies resulting from the Section 79 do not return a lot of money in retirement. It would be more beneficial for the business owner to take a smaller deduction and have a better cash value life insurance policy. With a quality CVL (i.e. Cash Value Life), the business owner would receive a deduction of only between 5 and 8% which hardly makes economic sense. So how does a quality Cash Value Life policy compare with the Section 79 returns in retirement? Please read on.
Section 79 Results: After Five Years Convert to a EUIL or Variable Life Policy
After five years, clients will have the option to convert the Section 79 Plan into a better policy, such as an EIUL (Equity Indexed Universal Life) or variable life policy. These life policies can earn around 9% each year. However, even with the presumption that the rate of return will be 9%, the retirement returns are comparatively less than the policies we use.
Life Insurance Agents Who Sell Section 79 plans
Why do life insurance agents push Section 79 Plans without full disclosure? Agents have two reasons for pushing these plans. Firstly, business owners hate paying taxes and are attracted to the tax deductions with the Section 79. Secondly, advisors want to make a sale. Most probably really do not care about the well being of the business owner as long as a sale is made or the life insurance agents have not scrutinized the return of investments of other retirement strategies.
Business owners need to be informed so they can make educated decisions regarding these plans. From a financial standpoint, these plans do not provide much in terms of financial benefits, asset protection, or wealth building for retirement. In many cases, an agent will suggest these plans because they know the owner is looking for tax deductions. However, this does not mean that the plans themselves are overly beneficial – there are better ways to get tax deductions. Life insurance agents will seldom take the time to crunch the numbers and present the true breakdown to a client. Life insurance agents should be comparing the Section 79 plans with other policies.
This is why business owners have to be aware of what they are buying into. Instead of getting involved with a Section 79 plan, most small business owners would reap more benefits from paying the business income taxes and then funding a good EIUL (Equity Indexed Universal Life) to generate wealth in retirement.
Section 79 with good tax deduction vs. After-tax purchase of a Quality Cash Value Life
Let’s compare the returns of a Section 79 which has an initial good tax deduction with investments of funds of after-tax income into a good life policy. A proprietor buys $150,000 in premiums to a Section 79 Plan and he is 45 years of age and will be paying the premium for a period of five years. The proprietor will then borrow money from the life policy when he is between the ages of 65 and 84. We will compare this scenario with another option, which is for the proprietor to pay the taxes and use money to fund a good cash value life policy for a period of five years. The proprietor will then borrow from the life policy from ages 65 to 84.
Section 79 loaned money that is tax free annually = $125,469
Quality policy loaned money annually = $187,626
Is the difference in the amounts actually worth the 40% deduction for the Section 79 Plan? Of course not. It would actually be a very poor choice on behalf of the business owner if he decided to use a Section 79 plan after seeing the math.
To see a breakdown of the financial calculations of the Section 79 plan, please Section 79 income.
Pro or Con? Section 79
Agents will try to convince business owners into using a Section 79 Plan by focusing on the deduction. Unfortunately, many business owners will not look into these plans and calculate the numbers before they jump right in. Keep in mind that life insurance advisors are incentivized to make money, which means they want to sell insurance. They really must have not calculated the numbers or do not care if these plans are the right or wrong path for the owner. This is why it is essential for business owners to be aware of these plans and ask for full disclosure from the advisor before making any decision.
Contact Estate Street Partners to discuss how we can help you plan for retirement and what is the best investment to maximize your retirement income.
In Retirement planning, variable Loans are common options in life insurance policies and are used when people are looking to borrow money from their policies. However, there is no way to determine whether the money left in the policy will continue to make money or if an individual will be forced to obtain funds to cover the interest charges for the loan. There are other options, including a policy that credits 140% of the annual returns of the S&P 500.
Variable Loan Options when Planning for Retirement
Variable loans are available with many policies from a variety of companies. These are usually used to enhance a product as well as the potential for a larger loan that would be tax-free for individuals who own a policy. In short, the company would continue to charge interest at a current rate on any money that is borrowed from the policy. For the sake of argument, we will say the rate is 5%. If the policy holder were to use a wash loan, the policy would be credited the same rate, 5%. When using a variable loan, the return on the investment will be unknown as it will constantly change, hence, the word ‘variable’.
Example of Equity Indexed Life Insurance Return
Let’s say an individual buys an Equity Indexed Life Insurance (EILI) and the growth that is in the policy is correlated to the S&P 500. Should the year produce a return of 11% on a policy that charges an interest rate of 5%, the policy holder would actually make money by borrowing from their policy.
Things change if the S&P 500 has a negative return for the year. In this case, the interest rate would remain at 5%. If the S&P 500 does not perform better than the interest rate, the cash that was left in the policy would be used to pay the cost of the interest on the loan. This results in the policy holder losing cash value inside the policy.
Example of Variable Loans Return
If the policy holder had been using a variable loan when the S&P 500 returned a negative amount, it is possible the individual would have heard from the insurance company stating that there are not sufficient funds in the policy to cover the cost of the interest. Another possibility is that the policy would lapse.
Insurance Companies Show Variable Loans Instead of a Wash Loan
Unfortunately, individuals who purchase a policy that has the option of a variable loan often do not understand why this option even exists. These policy holders only look at the amount that can be borrowed from the policy and do not consider the ramifications.
The problem is that the software that is used to display the loans’ forecast will default the interest on the loan. They will display the numbers for a variable loan instead of a wash loan. This can include a spread of 1-2%. The reason the variable loan is used in the software calculations is because, historically, the S&P 500 has always performed better than any interest rates by at least 2% each year. Even though this is the average, there is always the possibility that the S&P 500 could underperform. It happened in the 1980s where interest rates were over 15% at some point. During times like that, the policy holder would be in a world of hurt with a variable loan if the S&P 500 took a dive or went flat over an extended period of time.
Disclosure of a Variable Loan and Wash Loan
If you are even contemplating buying a policy with a variable loan option, you must make sure you have a complete understanding how the loan will work if you ever have to borrow against your policy. Make sure to get an output of the variable loan as well as a wash loan and take the time you compare the numbers. Even if the agent pushes a variable loan option, you should be aware that you have two choices available; the variable loan and a wash loan. Many agents will not disclose this information, so it is up to the individual to do some homework.
Equity Indexed Life Insurance Can Credit 140% of the S&P 500 Returns Every Year
It has been mentioned that some EILI policies will credit the policy holder with 140% of the return of the S&P 500 for the year. This is the type of policy that is preferred when dealing with a variable loan. To help you understand why this is a good choice, let’s set an example to make things clearer.
We will assume that a policy has an interest rate of 5%. Most policies will be pegged to the returns of the S&P 500, which let’s assume in a particular year is around 3.7%. In this case, the policy holder will be negative 1.3% because the return of the S&P 500 is less than the amount of the interest. This is why policy holders would benefit more from a wash loan. It protects them from the possibility of the S&P 500 underperforming the interest rate and reduces the chances of losing money when taking a loan on a policy. If the policy holder had chosen a wash loan, the policy would be credited with 140% of the S&P 500 returns and the individual would have earned 5.2% in the policy instead of losing 1.3%.
To change the numbers, let’s say the S&P 500 returned 2.5% for the year. The individual would then be negative 2.5% if the interest rate remained at 5%. However, if the individual had a policy that credited 140%, the loss would only have been 1.5%. This can amount to a huge sum of money.
Added protection is awarded to a individual when they have the 140% credit. At some point, the S&P 500 will underperform. There is never any way to know when this will happen, so in order to protect against huge losses, individuals would benefit from choosing a policy with the extra credit. In addition, the same type of policy will provide a no lapse guarantee for individuals over the age of 65.
