There are many ways that high net worth individuals can protect their wealth and their loved ones’ financial futures, but one method that has been gaining steam in recent years is premium financing life insurance. What is involved in this strategy, and when is it a good idea? Here is a closer look at what is involved in premium financing life insurance.
What Is Premium Financing Life Insurance: An Overview
In short, premium financing relies on borrowed money to cover life insurance premiums, normally in conjunction with a very large policy that pays a generous death benefit, so the borrower does not have to tie up their capital in paying the premiums. A closer look at the specifics of this approach is outlined below.
How Premium Financing Life Insurance Works
More than half of Americans currently have a life insurance policy in place to ensure that their loved ones are financially protected if they pass away. The premiums for these policies can vary significantly depending on the holder’s age, health, and policy type and size. A typical payout on a term life insurance policy is in the range of $100,000 to $250,000. This may be adequate for many individuals, but those who have a high net worth will need greater coverage – sometimes in the millions or tens of millions of dollars – to account for tax, inheritance and business issues.
However, the premiums on these types of policies can be very expensive. While an individual in their late 40s may be able to obtain a $250,000 policy for somewhere in the range of $30 to $40 per month, a whole life policy with a $25 million payout could cost upwards of $15,000 each month.
This means that the yearly premiums for these policies can cost hundreds of thousands of dollars. Although people who are looking into this strategy should have enough money to cover the premiums, it sometimes makes sense to get a loan to pay for them instead. This enables individuals to borrow the money at a rate that is close to the benchmark short-term rate so they can keep the money they would have spent on the premiums in other investments that are likely to yield a far greater return on their investment.
There is another big benefit of using premium financing life insurance that is also worth considering. Normally, high net worth individuals would trigger capital gains taxes if they liquidated assets to cover their premium upfront; this can be avoided by using premium financing.
Who Qualifies For Premium Financing?
There are a few criteria that lenders who offer premium financing look out for. The main qualification is that the insured is financially savvy and has a high net worth yet limited liquid assets. This strategy is typically reserved for people who are worth at least $5 million, but exceptions are sometimes made for those who earn an especially high income or who are using certain types of estate or business planning tactics.
The individual seeking premium financing should be under the age of 70 and in reasonably good health. They should also be able to demonstrate both financial needs and insurable interests. Most lenders will ask for additional collateral beyond the insurance contract, as well as involvement by outside financial or legal counsel. In addition, borrowers should be able to demonstrate an exit strategy beyond the payoff of the death benefits of the policy.
Are There Risks Involved?
Although premium financing life insurance can be a good strategy for some individuals, it is important to keep in mind that there are a few risks involved. One of the main risks is rising interest rates as premium finance loans typically come with variable interest rates attached to them. This can be extremely favorable when interest rates are low, but if they rise, it could minimize the advantages of this approach. This risk may be avoided in some cases by capping the interest rate or obtaining a fixed interest rate.
Another risk is the policy’s cash surrender value underperforming, in which case the balance of the loan may end up exceeding the collateral’s value. If this happens, the insured will be asked to offer more collateral to avoid defaulting on the loan. Similarly, should the death benefit fail to grow, the policy may not provide as much coverage as expected once the loan is fully satisfied. A worst-case scenario would see the insured’s estate being forced to repay the loan should the death benefit be unable to do so.
Reach Out To Vector Benefits
All borrowing strategies have risks, so it is important to weigh all the pros and cons to determine the best path forward. If you would like to explore the possibility of premium financing life insurance and other strategies for maximizing wealth, reach out to the professionals at Vector Benefits to discuss your objectives.