Solving complex estate and business planning problems often requires you to overcome a multitude of obstacles, challenges and objections, not the least of which is the cost of the life insurance policy your clients need to put their plans in motion.
How often have you discovered that your clients are reluctant to part with enough cash to actually pay for the life insurance policy and complete the planning process?
These clients fully appreciate the need for life insurance, especially if they have a large, illiquid estate. But concerns about the potential for lost investment income or, in some cases, increased tax liabilities, override their sense of urgency to take prudent planning steps.
Fortunately, there is a way to overcome these objections and help your clients complete their long-term life insurance planning in the process. Your clients may be able to satisfy all of their estate liquidity needs through the use of premium financing, an innovative financial strategy that allows them to leverage their savings and investments to pay life insurance premiums without having to liquidate those assets.
Premium financing arrangements are becoming more popular, especially with high net worth clients who have substantial investment portfolios.
Premium financing allows your clients to finance their life insurance premiums with dollars from a third-party lender. The cash for the premiums is borrowed from a private lender, which typically has a relationship with your clients’ life insurer and therefore may be able to offer attractive interest rates. By taking this approach, your clients can reduce their out-of-pocket costs for their life insurance coverage, keep their investment portfolios intact, enjoy attractive interest rates on the money they borrow, and effectively minimize gift taxes.
In a traditional funding arrangement for estate liquidity purposes, your clients typically use after-tax dollarsoften withdrawn from a personal investment portfolio or businessto pay for a life insurance policy owned by an irrevocable life insurance trust.
This creates two potential problems for some clients: 1) tapping investment assets to pay life insurance premiums can potentially reduce investment gains, and 2) the premium payments are considered gifts to the ILIT and may be subject to gift taxes.
A premium financing arrangement helps solve both of those problems. The cash needed to pay the life insurance premiums is borrowed from a third-party lender, leaving your clients investment portfolios untouched. The borrowed money is used to pay the life insurance premiums and the interest for the loan is typically paid annually. The loans principal may be repaid over time, or at the death of the insured.
The cash value within the life insurance policy itself may be used as collateral for the loan, although other collateral may be required. If the policys cash value is used for collateral purposes, the life insurance policy must not be a modified endowment contract.
Because policies purchased for estate-planning purposes tend to have large face amounts, the financed premiums tend to be large as well, often $100,000 annually or more. The loan interest typically can be paid in advance and the loan can usually be repaid at any time, without penalty.
Like credit card debt and general purpose loans, the interest on premium financing arrangements is generally not deductible. Interest on indebtedness to acquire or maintain a life insurance contract is considered personal interest, and is not deductible by an individual taxpayer.
Likewise, Internal Revenue Service rules generally disallow an interest deduction on a business loan used to purchase life insurance. Encourage your clients to seek advice from their legal and tax advisors as to whether a premium financing arrangement is in their best interests.
As an example of a situation where a premium financing program is in a clients best interests, lets look at a hypothetical case study involving John and Mary Hart. (See box.)
Despite the Harts initial premium funding obstacles, you probably wish you had more clients like them. They belong to an elite group of insureds whose life insurance needs are large enough to qualify for premium financing. For those clients whose business continuation or estate liquidity needs demand large life insurance policies, premium financing can be an attractive alternative to liquidating investments or business assets.
The next time one of your high-net-worth clients objects to the cost of a life insurance program you recommend, make sure the objection isnt masking a different problem. If you discover that he or she would rather keep money in the market instead of in a life insurance policy, you may have uncovered the need for premium financing.
Reproduced from National Underwriter Life & Health/Financial Services Edition, November 12, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.