Individuals with the need for large amounts of life insurance for estate liquidity purposes will also need to manage large premium payments. This can often present a challenge. It is not easy for some families to generate large after tax cash flow and as the policy is usually owned by an irrevocable life insurance trust (ILIT) there are limitations as to how much can be gifted each year by each spouse (generally limited to $13,000 per person listed as a possible beneficiary in the trust).
By utilizing a bank (or other loan facility), the trust is able to borrow the necessary premiums needed to fund the policy at extremely attractive rates. There are no gifting issues to deal with since this is a loan to the ILIT and not a gift from the insured. Most loans are based on LIBOR plus a spread of 1-3% based on the size of the loan. An average rate today would be around 2.5%. If we look back to 1995, we find that the one month LIBOR rate was 6%, in 2000 it was 2.5% and today it stands at about .30%. Some arrangements require that some or all interest be paid annually but more are allowing for a “roll up” of interest into the loan eliminating the need to pay any monies toward the loan.
Collateral for the loan is generally required and is an amount equal to the difference between the cash surrender value of the policy and the outstanding loan. These collateral monies can often be invested in stocks, bonds, etc. just as you would now. The lender simply has the collateral assets managed in their custody.
One of the disadvantages of premium financing in the past has been the death benefit would be reduced by the outstanding loan. Some life insurance carriers have designed policies where the death benefit rises each year by the amount of the loan thus providing the full face amount to the ILIT at the insured’s death! There are always risks when borrowing for long periods of time but we have found the arrangement very favorable for our clients since 1995.
There are many nuances to review and due diligence with your advisors is a must; however, life insurance premium finance is worth considering for high net worth individuals or families.