Premium Financing? What is That?

I want to introduce a concept that has become popular over the last few years since interest rates have gone down. It is a concept called Premium Financing, with which wealthy people can acquire needed life insurance liquidity for trusts set up for their families. Estate tax is then paid through the life insurance trust rather than having to liquidate their properties, businesses, real estate, and/or stock portfolios.

Many of the people that we work with have quite a bit of wealth but sometimes that wealth is tied up in real estate, corporations, and/or businesses and not readily available. I describe someone’s estate as a big glass of ice water. What the government wants to do is take out all the liquid first, so they put their straw in and they suck out all the liquid. What is left are the ice cubes, the real estate, the businesses, which is where a lot of the wealth is. Sometimes in order to get these “ice cubes” liquidated, they have to be broken up and sometimes the timing is not advantageous. The past few years have not necessarily been the best time to sell real estate, but if my assets were all tied up in real estate, and I had a tax that was due, I wouldn’t have a choice.

Families would do very well if they created a plan by which they could create tax free dollars through life insurance. The problem is, how do they pay for it if all of their assets are tied up in real estate or business? They may not have the liquid dollars, not only to pay their tax but to pay the premiums on these types of life insurance products.

The answer could be a concept called Premium Finance. Premium Finance is an arrangement between:

• The insured
• A life insurance trust
• The lender – A third party (bank or finance company)
• The life insurance company

Typically, the way it works is, they set up a trust and rather than the insured grantor paying money into the trust and then the trust buying the life insurance, we finance the premium and work with a third party. That third party, a bank/finance company, will make the payments for the insured’s life insurance policy that is owned by the trust outside of the family’s estate. There is a lien against the policy so if something were to happen, the finance company would get its money back.

The bank/finance company will charge an interest rate, commonly about 1/2 a point above what they call LIBOR (London Interbank Offered Rate). Let’s say, for argument’s sake, the rate is 3%. If the premium is say half a million dollars, the insured does not have to come up with that amount. He borrows from the bank, which will then pay the half a million dollars. The insured or the trust, will be responsible for paying the interest.

What we have been doing is using a life insurance policy product that is paid off in 10 years. After 10 years of paying a half a million dollars per year, there’s a loan of $5 million. What the creditor has is the ability to use the policy as collateral. The policy has a death benefit and cash values and these values are assigned as part of this arrangement, which allows them to be in a position where they’re comfortable with the policy acting as collateral. Sometimes there is a requirement for something called gap collateral so that if the policy doesn’t have enough value in it and the person defaults, the bank would be able to get its money back.

After 10 years, the policy would be paid off, and you would have a loan of 5 million dollars against it. You paid the interest on the loan each year and then let’s say some 5, 10, 15 years later, you are in a position where the interest on the loans and the loan principal get paid back. Once the loan is paid back on the premium financing arrangement, you now have a life insurance policy, owned and set up where your family and you do not have to liquidate properties in order to buy the life insurance. And you have a plan to pay the estate taxes without liquidating real estate, business interests or other illiquid assets.

This kind of concept has gained a lot of popularity over the past 10 years or so, as interest rates have gone down. It allows people to access solutions that they might not have felt they could access because they didn’t have the liquid dollars to pay for the life insurance. But even worse, they didn’t have the liquidity to pay the taxes. A lot of clients who are in real estate or own businesses, like the idea of acquiring the life insurance for the estate plan even though they don’t have the liquidity to do so. This concept of premium financing can be really attractive for some people in this situation.

Below is a chart so that you can see graphically how this arrangement works.

Do you need to create tax free dollars through something like life insurance to help protect your wealth? If you are an individual interested in Premium Financing for your Whole Life Insurance, please click here.* Premium Financing may just be the concept you need. Please let us know what questions you may have regarding this concept. All of us at Strategic Wealth Advisors Network will be happy to try and help you.

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