The essence of premium financing, as the term suggests, is where the affluent individual takes out a loan to pay for his or her life insurance policy. There are a number of reasons this can be a wise financial move.
The advantages of borrowing life insurance premiums are tangible and valuable. This payment strategy can potentially increase a wealthy person’s net worth modestly during his or her lifetime and increase the after-tax estate substantially after death. Premium financing also creates the flexibility to adjust the amount of leverage built into the life insurance policy when initially purchased and periodically over time.
A 54-year-old real estate developer had a need for US$100 million of life insurance to fund estate taxes. Most of his cash assets were tied up in his properties. The annual premium to pay the policy outright was a little more than US$1.8 million per year for his lifetime for a level death benefit policy. On top of that, the client did not have enough annual exclusion (gifting) beneficiaries so he would have to pay additional gift taxes on the premiums being paid to the trust that would own the policy.
Since the developer was used to leverage as he had bought so many of his properties that way, we looked into a premium finance arrangement. The developer’s trust, which would own the policy, was able to borrow the policy premiums from a third party lender. He funded the policy at high levels in order for it to be self-supporting after seven to ten years. Since the policy would be funded at very high levels, the cash value would collateralize most of the loan. The developer would post collateral for any shortfall between the policy cash value and the loan balance. The annual interest charged on the loan could be paid annually or accrued into the loan. This gave him a lot of flexibility for cash flow management.
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