In 2016, the University of Michigan and Jim Harbaugh came to an agreement in which Michigan would loan Harbaugh $14 million over the course of several years to pay his insurance premiums. He doesn’t need to repay the loan until he dies, at which point the death benefit will cover the loan, and remaining funds will go to his beneficiaries. It’s a win-win; Harbaugh insures his legacy, and the school gets a guaranteed payback (not to mention snagging and retaining a winning coach).
This high-profile case is only one example of the many forms of premium financing. Lenders have developed entire books of business around financing insurance premiums for high net worth clients. While each case is different, the insured will typically make an annual payment to the lender for interest accrued on the loan. In exchange, the lender provides the full insurance premium payment. In order to obtain the loan, the insured must post collateral, a significant portion of which could be the insurance policy cash value. The loan could be repaid in full when the death benefit is disbursed.
Why Finance Insurance Premiums?
- Retained capital-Whole life insurance policies can become costly, especially when purchased later in life, and especially when the coverage needed is several million dollars. Let’s use a simple example where your money is earning a 12% return annually, and the insurance premium is $200,000 per year. Rather than pay out all that cash, you could finance the premium, pay only $10,000, and keep the remaining $190,000 invested, earning $22,800 in year 1. You now also have a life insurance policy to protect your assets over the long run.
- Avoid liquidating assets – In order to obtain the cash to pay high premiums, some other assets would have to be displaced. If the assets are in the form of traditional investments, liquidating those assets could trigger capital gains taxes. This may be especially troublesome on highly appreciated assets. If the assets are in the form of property or a personal business, you may not be ready to sell; instead they could be used as collateral for the loan.
- Retain talent – Businesses can finance premiums (or pay premiums) as an alternative form of compensation for executives; adding to their estate and retirement planning in a meaningful way while keeping them locked in to the organization if they want to maintain policy coverage.
- Supplement Income – Business owners an use the business to pay their insurance policy premiums as a form of compensation that is tax deductible (as a business expense). Loans on the policy are tax-free and generally fee-free (requiring no repayment if planned properly), so it can also become a form of supplemental income that is not taxed.
Finance Responsibly
There are a few risks that should be addressed by the insured at the planning stages when financing premiums:
- Interest rate risk: If the rates on the loan are variable, there is a chance the rate could go up, and the loan interest could accrue faster than the policy cash value. A fixed rate loan or interest rate cap can mitigate that risk.
- Earnings risk: If the life insurance policy is not performing as expected, the cash value could drop below the loan value. In this case, additional collateral may be needed for the bank to continue to fund the policy. An indexed insurance policy could help safeguard the policy from losses.
- MEC risk: You may want to fund the new policy well up front so that the cash value increases rapidly, reducing the earnings risk (mentioned above). However, a careful advisor will also ensure that you don’t fund so much that it becomes taxable as a modified endowment contract [MEC].
- Insurance Company risk: A downgrade in your insurance company’s rating could adversely affect the loan, but if you work with a well-established firm, you can reduce this risk.
Case in Point
Allison moved to L.A. in her 20’s, and after years of hard work, became a much sought-after make-up artist, eventually opening up her own make-up school. Now in her 60’s, her business is worth $20 million dollars, and her other assets, mainly property, constitute another $5 million. Allison represents just one type of client that would benefit from premium financing:
- Allison’s estate will likely exceed $25 million, and if she dies in 2026 or later, only about $5 or $6 million will be exempt from estate taxes. Let’s assume her estate will be taxed on $20 million at 40%; a total of $8 million owed to the IRA.
- She wants to open a life insurance policy (within an irrevocable trust so that it is removed from her estate and becomes exempt from estate taxes). The policy death benefit will cover the estate tax payment. This is highly beneficial since her son Alex may not want to sell the business or the property right away in order to pay Uncle Sam.
- The life insurance premiums on an $8 million policy are easily $150,000 per year. Allison doesn’t want to liquidate her assets. Here is where financing the premiums fits in.
- Allison decides to take out a $12 million life insurance policy to be safe. Her premium payments are $300,000 annually, but she only has to pay the bank $15,000 per year. The death benefit will pay back the loan in full, plus Alex will have the money needed to pay estate taxes.
- Allison can sleep easy knowing that she is taking care of her legacy, while continuing to grow her business.
Each case is unique. It’s best to work with an experienced advisor to determine whether the premium financing option is right for you. If you need help getting started, our team at Axia Global can help; just give us a call. Our goal is to make a measurable difference in your financial life.
Note: the statements above should not be considered financial, legal or tax advice, but ideas for careful consideration with your trusted financial advisors and lawyers. For current tax or legal advice, please consult with an accountant or an attorney.
About Axia Global
J. Michael Roney, founder of Axia Global, has worked alongside the best financial and legal professionals in the field for decades. He has written a book on wealth preservation, and his calling is to craft profitable solutions for even the most complex wealth preservation and estate planning cases. Together, the team at Axia Global has nearly a century of combined experience in the financial services sector.
