WHAT IS PREMIUM HOW DOES PREMIUM FINANCING? FINANCING WORK?

Transcription

1 Life Insurance Premium Financing 1 of 5

2 WHAT IS PREMIUM FINANCING? Premium financing allows individuals who have a life insurance need to defer using their liquid assets to fund a life insurance policy. In a premium financing arrangement, you (or your trust or corporation) can take out a loan from a third party lender to pay the premiums on a life insurance policy. Premium financing can significantly reduce out-ofpocket costs as well as gift tax costs on large life insurance policies. CANDIDATES FOR PREMIUM FINANCING The candidates for premium financing are usually individuals who are age 60 or older, whose net worth is approximately $5 million or more, and who would need a life insurance policy with a minimum annual premium of $100,000 or more. These individuals may be business owners, or may have the majority of their assets tied up in real estate or other investments. The financing allows you to leverage a new life insurance policy by paying only interest and maintaining your other investments. If you fit this profile, then you may want to consider life insurance premium financing. HOW DOES PREMIUM FINANCING WORK? With premium financing, the potential insured applies for premium financing after he/she has been underwritten for a life insurance policy. Once the lender approves the insured for a loan, it will finance the annual premiums on the life insurance policy and the policyowner (usually a trust) will only have to pay interest annually. The life insurance policy and other liquid assets are used for collateral against the loan. The loan may be repaid in a lump sum, in installments over time, or at the death of the insured. WHAT ARE THE REQUIREMENTS FOR A PREMIUM FINANCING LOAN? Each bank or lending institution has different requirements for premium financing. Some banks, such A.I. Credit, Wells Fargo and Mellon Bank have established premium financing programs. Provada has an an arrangement with a premium finance lending broker who can bring multiple sources for consideration. In addition, you may also consider using a local bank with which you have an established relationship. Although each lender s terms vary for premium financing, a loan must typically meet the following requirements: 1. The insured must be underwritten for a new life insurance policy and qualify financially for premium financing. 2. The borrower will pay interest annually at the beginning of the year, although some arrangement allow for interest to be paid at the end of the year or accrued for a specified period. 2 of 5

3 Basic Strategy Diagram During Life Engagement into Loan Agreement Client & Advisors Negotiate Loan Terms Premiums & Loan Interest Financing Institution Collateral as Needed Collateral Source Insured, Parents, Children, Trust(s), Family Partnerships, Family LLC, Corporation Pays Premiums Policy as Collateral Life Insurance Trust (owner of policy) Life Insurance Company Trust Receives Tax Free Death Benefit Proceeds At Death Life Insurance Policy Life Insurance Trust (owner of policy) Loan Repayment Financing Institution Net Proceeds to Heirs Collateral Released After Loan Repayment 3. The loan interest rate is reset every year, depending on the terms of the loan (some lenders may offer fixed rates for a period of time). 4. The loan is collateralized by the insurance policy and will also require a secondary form of collateral. 5. The lender takes a collateral assignment in the cash surrender value and death benefit of the financed policy. 6. The client signs a personal guaranty on the loan. 3 of 5

4 WHAT IS SELF-FINANCING? You may also want to consider the Self- Financing approach where you or your trust or partnership loans all or part of the annual premium to an irrevocable life insurance trust (ILIT) and the ILIT only has to pay the annual interest cost. 2 For self-financing, you would act as the bank and would use available cash to advance annual premium loans. This approach avoids the financial underwriting and collateral requirements of using a third party lender. As with traditional premium financing, selffinancing can significantly reduce gift tax on large premiums since the premium loan is not considered a gift and only the annual interest cost needs to be gifted to the ILIT. HOW IS THE INTEREST RATEDETERMINED ON A LOAN? Each lender will calculate interest in different ways. Most lenders will calculate interest based upon the oneyear London Interbank Offered Rates (LIBOR) or the PRIME rate and a fixed spread. 3 Although some lenders will offer fixed interest rates for five or tenyear periods, many will offer lower interest rates that are adjustable annually, based on LIBOR or PRIME. For the self-financing approach, the interest rate on the loan should be set at or above the current Applicable Federal Rate (AFR). 4 WHAT TYPE OF COLLATERAL CAN BE USED? In addition to the life insurance policy, the lender usually needs a secondary form of collateral to secure the premium financing. Assets that can be used for collateral typically include cash and cash equivalents, marketable securities, a letter of credit, existing life insurance policies, and certificates of deposit (CD). Marketable securities such as stocks and variable life insurance policies are usually discounted 50% to account for fluctuations in the market value. Most lenders will not take real estate as collateral for premium financing, but real estate or privately held stock may be used to secure a Letter of Credit. USES OF PREMIUM FINANCING Although premium financing is often used for estate planning purposes, it can also be used in other situations such as 1035 exchanges to new policies, non-qualified deferred compensation, buy-sell agreements and key person life insurance. 4 of 5

5 This material is for informational purposes only. Although many of the topics presented may also involve tax, legal, accounting, or other issues, neither Provada Insurance Services, Inc., nor any of its agents, and employees are in the business of offering such advice. Individuals interested in these topics should consult with their own professional advisors to examine tax, legal, accounting, or financial planning aspects of these topics. 1 Trusts should be drafted by an attorney familiar with such matters in order to take into account income, gift and estate tax laws (including generation-skipping tax). Failure to do so could result in adverse tax treatment of trust proceeds. 2 Upon death, the loan from the insured to the ILIT will become an asset of the taxable estate, and the principal balance at death will be subject to estate tax. 3 It is important to note that the LIBOR rate is not fixed and may be different from the initial rate used in the illustrations. The monthly LIBOR rate from January 1992 through January 2002 ranged from a low of 2.31% (October 2001) to a high of 7.75% (December 1994), with an average rate of 5.46%. 4 The IRS publishes the Applicable Federal Rate on a monthly basis. Provada Insurance Services, Inc. 201 Mission St., Suite 1940, San Francisco, California PROVADA ( ) info@provada.com CDI #0E Provada Insurance Services, Inc. All rights reserved. 5 of 5