Financing Life Insurance Premiums

By borrowing money to pay for the premiums, you may be able to maximize the benefit of the life insurance policy while minimizing your exposure to taxes and leaving your current investment strategy intact.

If you anticipate a need for liquidity upon your death, whether to cover the taxes due on your estate or to facilitate a smooth transfer of your business, a life insurance policy with a substantial death benefit could be a wise addition to your wealth and estate plan. Unfortunately, the premiums associated with such a plan can be significant. You may need to liquidate investments to cover the cost, potentially exposing yourself to gift or capital gains taxes and reducing your ability to take advantage of growth in your portfolio.

There is, however, another way. By borrowing money to pay for the premiums, you may be able to maximize the benefit of the life insurance policy while minimizing your exposure to taxes and leaving your current investment strategy intact.

Is Premium Financing Right For You?

Generally speaking, premium financing is a suitable strategy for those with a net worth of $25 million or greater who wish to use insurance to provide the liquidity necessary to pay estate taxes and ensure that they are able to pass their legacy assets on to their heirs. This strategy serves those individuals who do not want to sell off investments or allocate current income to addressing that need. Whether or not it makes sense in a particular case depends on a number of factors: how much insurance is needed, what the associated costs are and, whether or not there may be alternative estate planning techniques that satisfy the need.

If you are considering this strategy, begin by working closely with your attorney to devise an estate plan. If you decide you need insurance, reach out to a life insurance professional. Trying to determine the appropriate policy can be a complex and challenging undertaking, and a life insurance professional can help you select the policy type and amount that's appropriate for your situation. Your advisors can also help you determine the ownership of the insurance policy. It's important to explore all your payment options, based on your individual situation and financial needs. While premium financing may be the right strategy for you, you should first consider if you would be better served by paying the insurance premiums outright.

Because the interactions between the life insurance policy, your estate plan, your investments and the loan are complicated, it's critical that you work closely with a team of advisors who have experience and expertise in these matters and understand your financial situation. There is not a "one-size-fits-all" optimal strategy when it comes to this topic. Therefore, it's imperative that your team of professionals can coordinate and work together to help you determine the best choices for you, given the potentially millions of permutations.

How Premium Financing Works

Those who are confident that premium financing is right for them typically set up an irrevocable life insurance trust (ILIT).

This trust is designed to own the life insurance policy, which means the policy is owned outside of your taxable estate. The beneficiaries receive the death benefit free of estate and income taxes. The ILIT would then take out a loan in order to pay the premiums. Typically, the policy is used as collateral. In the early years, the cash value of the policy will not be sufficient collateral for the loan — you may need to use a portion of your investment portfolio to make up the difference.

By funding the ILIT with a loan rather than direct contributions, you can limit your exposure to gift taxes and avoid exhausting your lifetime gift tax exclusion. Annual contributions to the ILIT may be needed to cover interest payments on the loan, but are typically less than the premium and may be within your annual gift tax exclusion limit.