Premium Financing seems to be the “best kept secret” in the financial industry recently, and unless your financial professional keeps up to date on the best techniques, he may be just as uninformed as anybody. Simply put, Premium Financing is having ones Irrevocable Life Insurance Trust borrow funds from a bank to cover the cost of insurance for a large insurance policy. This tool can be advantageous to those of high net worth to not only fund large insurance policies, but to create liquidity at death as well as reduce income, estate, and gift taxes.
The way that it works can be simply stated as well. Essentially, one sets up an Irrevocable Life Insurance Trust (ILIT) which is the owner and beneficiary of the Premium Finance Policy. Once the ILIT is in arrangement with the bank, who is the lender of the premiums, one collateralizes assets to ensure the bank’s return of their loan. Note that this is only collateral and you do not liquidate these assets. The bank then pays the policy’s premium for the allotted amount of years. The Premium Finance client may however have to pay interest to the lender because Premium Financing is not free insurance. It is merely implemented to reduce premium payments for the proposed client. The death benefit is then paid out to the trust after the client passes, which is generally income-tax free. Once the trustee pays the outstanding loan from the death benefit, the outstanding balance is saved to benefit the deceased’s heirs.
Premium Financing is very beneficial and valuable to those who want to avoid taxes upon death with a substantial death benefit while still retaining their assets while they are still alive and well. By leveraging these assets for a larger premium paid by the lender, the death benefit grows. When the death benefit is paid to the trust, it is generally paid income tax and estate tax free leaving more for your heirs. Not only is this benefit potentially income and estate tax free, but it may be able to avoid taxable gifts. Depending on how many beneficiaries your trust names, the contributions to each may be eligible as an annual exclusion gift which is nontaxable. While reaping the benefits from the larger death benefit, you still retain control of your assets without liquidation.
While Premium Financing is a very advantageous strategy for some, it does have associated risks. Interest rate risks may be the most known, due to the rate’s fluctuation over time. Collateral requirements may increase if the lender deems necessary such as additional assets, or a letter of credit. Additionally, arrangement fees may apply. As always, speak to your trusted financial advisor to see if this opportunity may be appropriate for you and your financial situation.