Funding Life Insurance with Loans from a Third Party Lender
What is it?
Premium financing is a way to pay the premiums on a life insurance policy – which is usually held in an Irrevocable Life Insurance Trust (ILIT) – by borrowing money from a third-party commercial lender.
Who is it good for?
Premium financing isn’t a strategy for everyone. Because these are complex transactions, candidates for this strategy can pay significant life insurance premiums out of pocket. But, particularly in a low interest rate environment, the leverage benefits can outweigh the premium cost. Premium financing makes sense for clients who:
If you have any questions about premium financing, contact our team of dedicated agents at 888-379-0270 or come by our office today!
Who is involved in the premium financing equation?
- Legal and Tax Advisors – This role works to determine if premium financing makes sense for the insured’s/grantor’s situation.
- Lender – An institution (normally a bank) that provides the financing for the transactions.
- Insurance Professional – An individual who helps to identify the insurance need and sells the life insurance policy.
- The Insurance Company – The entity that provides the life insurance product being purchased.
How it works
- The insured/grantor establishes an ILIT (irrevocable life insurance trust) to own the life insurance.
- The insured/grantor works with the lender and sets the terms of the loan, interest rate, transactions fees and collateral requirements.
- The insured/grantor applies for the life insurance policy.
- The insured/grantor pledges the life insurance policy and additional assets at least equal to the outstanding principal and interest as collateral.
- Generally, your ILIT will pay loan interest each year on the outstanding loan at the rate set by the lender.
- During the life of the loan, the life insurance cash value and external funds will be used as collateral for the loan. Typically, the insured will guarantee the loan and post collateral.
- When the note is due to be repaid, the insured is responsible for paying off the debt. Lender – An institution (normally a bank) that provides the financing for the transactions.
Common exit strategies
- Death Benefit – For estates that will need liquidity at the grantor’s death to pay estate taxes as the debt is repaid with cash from the insurance policy. Good for older insures, when substantial liquidity is needed for estate tax or other purposes, or when Return of Premium Rider is added to the policy, increasing the initial death benefit by a portion of the premium paid. With this rider, the ILIT can repay any outstanding indebtedness without reducing the original death benefit intended for the ILIT beneficiaries. This rider is costly and generally will be much higher than the policy without the rider.
- Policy Cash Value – The trustee can use some of all the cash value built up inside a life insurance policy to repay the loan. The risk to this approach is that typically cash value growth cannot be guaranteed and is subject to investment and/or credit rate risk. Consequently, there is no guarantee that enough cash value will be available to repay the debt. Moreover, once the policy cash value is surrendered, the death benefit will decrease, leaving less for the ILIT beneficiaries.
- Pemium financing may allow the funding of a large life insurance need at a low interest cost without affecting current cash flow.
- You can borrow cash from a lender without liquidating taxable investments that are earning a higher rate of return than the loan interest cost.
- You can acquire life insurance coverage without giving up use of assets.
- Financing through a third-party lender may help reduce your gift-tax exposure, because loans made to your ILIT will not be subject to gift tax.
- The loan interest rate may fluctuate over the term of the loan, and you may end up paying a higher than originally illustrated rate – it is important to pay loan interest each year to control the growth of the loan.
- Interest paid on loans used to acquire life insurance is not deductible for income tax purposes.
- Collateral requirements are set by the lender- to the extent the outstanding loan balance exceeds the policy’s cash surrender value, you may be required to post additional collateral that may be larger than what was originally discussed or illustrated at the time you entered into the transactions.
- The lender will likely require an annual financial re-certification.