Financing life insurance premiums can be a powerful, flexible, and tax-efficient option for permanent life insurance premium payments for eligible clients.
Whether an individual desires an additional tax-free income stream in future years, a tax-efficient cash accumulation strategy, or a significant death benefit to pass to their heirs, premium financing may be a cost-effective strategy that, by using leverage, can be structured to meet a myriad of objectives.
Understanding Leverage in Life Insurance
Successful investors and businesspeople understand the wealth-creating power of leverage. For insurance policies, it involves borrowing money from the bank and then using those borrowed funds as a premium payment, with the expectation to earn a higher return than the interest an individual is paying.
Most banks typically lend based on LIBOR (London Interbank Offered Rate). Banks will also add a small spread over LIBOR for themselves. These rates move daily, based on an average, and will fluctuate during the length of the loan. The daily rates are easy to verify on the internet and banks offer full transparency.
Structuring for Tax-Free Cash Accumulation
Building up cash in the policy is an effective way to grow leveraged dollars in a tax-free environment. The cash value in the policy has the flexibility to be accessed, via distributions, during an individual’s lifetime for additional cash flow potentially tax-free. While an individual may take distributions at any time, they also may opt to allow the cash to continue growing over time as a tax-efficient investment.
Structuring for Estate Planning (Death Benefit)
Financing life insurance premiums with estate planning in mind is ideal for those who desire a substantial amount of life insurance – for business planning or to transfer wealth to future generations – but who don’t want to write significant premium checks.
Whether it’s for lack of liquidity or having access to multiple investment options, individuals would rather use the bank’s money and pay interest at a low rate in order to provide their beneficiaries with death benefit in the future.
Achieving the Spread
Insurance has long been used by high net worth investors with the goal to potentially achieve a tax-efficient return. At Schechter, we tend to prefer Index Universal Life policies (IULs) as there is an annual collared return on an equity index, typically the S&P 500, with a floor and a cap. The insurance company guarantees the client will not earn less than the floor and/or more than the cap in any given year.
Over the long-term, we believe there is some predictability on how these policies will perform due to the collared environment. We take advantage of that by borrowing from the bank at a lower rate than we expect to receive in the policy as a credit. By earning the difference in the spread, we are essentially arbitraging interest rates with the percent a client is credited in the insurance policy.