How does Premium Financing Life Insurance Work?

Thang Truong
Thang Truong
Updated on:

You’re probably familiar with financing for your car, your home, and possibly other big-ticket items. But did you know you can also finance your life insurance policy? That is called premium financing life insurance. Simple right? The only catch is, you have to be worth at least $5 million dollars. 

What is Premium Financing Life Insurance?

Premium financing life insurance is like any other financing, in that you take out a loan from a third party to pay the life insurance policy’s premiums. Like every other loan, that third party charges interest. Then, when your life insurance policy earns enough cash value, you pay back the original loan and the interest and you are left with the life insurance policy and the death benefit.

These are universal life or whole life insurance policies because term life insurance doesn’t earn any cash value. The third-party (the bank) lends the money and sets up what’s called an irrevocable trust, which holds the life insurance policy. The life insurance policy is used for collateral for the loan. This leaves the life insurance policy outside of your assets and gives your heirs an attractive tax-free inheritance.

>>MORE: Understanding Indexed Universal Life Insurance (IUL) – Why Is It Good for Retirement Savings?

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Who is Premium Financing Life Insurance For?

Qualified clients, in other words, people with a high net worth who are seeking millions of dollars in insurance should consider premium financing life insurance. It spares your liquid assets from being tied up in life insurance policy. 

If you’re seeking $10 million dollars in life insurance, the premiums on a term insurance policy would be roughly $550 a month, assuming the client is young and in good health. For a whole life insurance policy, the premiums would be a staggering $8,235 a month. That’s a lot of money to tie up in premiums every month. Many clients are looking for policies upwards of $25 million, which would result in even higher premiums. If you have that much money, you could invest it in something else that would yield a higher return on investment (ROI). 

>>MORE: Indexed Universal Life Insurance (IUL) vs. Whole Life Insurance: Which is Better?

How does Premium Financing Life Insurance Work?

The loan is set up as an irrevocable life insurance trust (ILIT). The trust technically owns the policy. This means it’s not part of the client’s estate. The ILIT takes out a loan to pay the premiums on the policy with the policy itself as collateral. The premiums are paid from the loan and the loan is paid back from the cash value. When the policy doesn’t have enough cash value, the client must repay the loan with other money. 

Pros of Premium Financing Life Insurance

  • Less capital tied up in insurance premiums
  • Investments pay out-earn the borrowing costs
  • You might be able to purchase more life insurance this way, as opposed to paying for it out-of-pocket
  • Reduces or eliminates gift taxes
  • Death benefit is tax-free and passed onto your heirs
  • You won’t trigger any capital gains taxes as you would have if you liquidated as asset to pay for the premiums
  • Allows client to obtain life insurance coverage without any cash

>>MORE: When is Permanent Life Insurance the Right Choice? Case Studies

Cons or Risks of Premium Financing Life Insurance

Why doesn’t everyone buy life insurance this way? Premium financing life insurance is not without risk. 

  • If tax rates rise and the cash value doesn’t keep up, you will have to pay for the difference out-of-pocket
  • If you surrender the policy, you lose the tax advantages
  • If you die before the loan is paid off, the bank gets a portion of the death benefit
  • If the loan lapses, the lender could come after your personal assets
  • If interest rates increase dramatically, you could owe more money than the policy is worth
  • If the policy is worth less than the amount owed and you surrender the policy, you would be in debt for the remainder
  • Premium financing loans have shorter durations than the life insurance policy, typically one-year, which means the interest rate could go up every time it renews
  • You have to pay interest on the loan, which you wouldn’t have if you paid for the premiums out of pocket

>>MORE: Is Whole Life Insurance Good for Retirement Savings?

Exit Strategy

How will you pay off the loan? What if you become underwater with the loan (when you owe more than the policy is worth)? 

Clients should meet with their financial advisors to answer these questions, and to determine what their goals are. Also, premium financed life insurance needs to be monitored quite closely to make sure it pays off. Make sure your financial advisors know what you are trying to accomplish. 

Alternatives to Premium Financing Life Insurance

Premium financed life insurance is for high net worth people seeking life insurance policies in the tens of millions of dollars. The fact that they are worth a lot of money makes the bank more willing to lend them the money for life insurance. 

Such individuals could consider paying cash for a universal life insurance policy. It would be expensive, but you wouldn’t have to pay back any loans, which makes it a much simpler process. 

People who are not worth millions of dollars should consider a term life insurance policy. This provides financial relief to your heirs in case you die, which is what life insurance is for. 

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Last Thoughts

Premium financed life insurance is not for everyone, but rather high net worth clients who want estate planning without a large outlay of cash. They should meet with their financial advisor to settle on a strategy for this type of investment. If you’re looking for estate planning and a way to transfer wealth without your heirs having to pay taxes on it, premium financed life insurance could work for you. 

Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

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