Borrowing to Buy: Why Premium-Financed Life Insurance Makes Sense

Key Takeaways:

Premium-financed life insurance can help provide your family needed liquidity and help pay estate taxes when the time comes.

Financing life insurance premiums can save huge sums and free up cash to reinvest in your business.

Too many financial advisors fail to offer this solution to their business owner clients.

If you’re like most successful entrepreneurs, you’re deeply concerned about your family members’ well-being—which means you don’t want to leave them dealing with tremendous financial uncertainty after you’re gone.

But the fact is, estate taxes can be especially bruising to business owners and their families. When the time comes to pay the bill, family members often find themselves struggling to figure out how to get at illiquid company assets—a financial stressor that they most certainly don’t want to suffer as they mourn and work to get back on their feet emotionally.

You can avoid putting your family through that experience with wealth planning—if you do it right.

There are many tools to help you plan your estate and ensure the money is there when it’s needed for taxes and other expenses. One of the most effective methods we’ve seen used among the most successful business owners and the Super Rich—people with a net worth of $500 million or more—is premium-financed life insurance.

Here’s a closer look at how premium-financed life insurance can help you build wealth and ensure liquidity is at the ready during one of the hardest times any family can go through.

The benefits of borrowing

With premium-financed life insurance, you borrow the money needed to buy the life insurance that you can eventually use to cover estate taxes. When financing life insurance premiums, you borrow money from a third-party lender. You are, at some point down the road, responsible for paying back the loan (with interest). Sometimes you pay the interest along the way instead of letting it accumulate.

The good news: The internal, tax-free growth of the money inside the life insurance policy can potentially be used to cover some or all of those costs.

Other benefits of premium-financed life insurance:

• You can keep more assets invested in your business or in other investments rather than use them to pay insurance premiums out of pocket.
• There may be flexibility if tax laws change over time.
• Because of the borrowing feature of PFLI, you can ensure you have the appropriate amount of life insurance if your cash flow situation wouldn’t allow you to purchase that amount outright.

There are a number of ways to structure a premium-financing transaction. For example, while you borrow the money to pay the premiums, you could pay the interest on the loan annually. Conversely, you can wrap the interest into the loan itself. Depending on the approach you take, the life insurance policy can be used as collateral (or other forms of collateral might be employed).

An underappreciated option

Unfortunately, there are relatively few financial advisors who understand how premium-financed life insurance works and how to integrate it into a business owner’s larger financial situation to achieve key goals.

A little more than 40 percent of financial advisors or the specialists they are associated with report that they are knowledgeable when it comes to financing life insurance (see Exhibit 1). But, according to our research, fewer than 5 percent have completed a premium-financed life insurance transaction with a client.

It’s hardly surprising, then, that just a little more than 10 percent of successful business owners are using premium financing (see Exhibit 2).

Your next steps to plan your estate

Estate planning can help you transfer the wealth you have built according to your wishes, desires and goals—giving you peace of mind that the most important people in your life will be taken care of as you see fit. In addition, it can generate tremendous tax benefits that allow more of that wealth to go where you want it to instead of to the government.

The complication is that relatively few successful business owners are taking many of the actions available to them to effectively manage their estates for maximum benefit. True, we see that most successful business owners have estate plans. The more sophisticated wealth management solutions that could do business owners the most good—such as premium-financed life insurance—are likely not being used nearly enough. One big reason: Too many financial professionals aren’t in a position to deliver these solutions to their business owner clients.

If you are like most successful business owners looking to become seriously wealthy—that is, you are concerned about your loved ones, are charitably inclined or want to change the world—then it is imperative that you make sure your estate plan is current, relevant and optimally structured to ensure that your wealth does exactly what you want it to do. That means it is imperative to work with someone who has the capabilities and resources to get the job done right.

CASE STUDY: One business owner’s approach

To see how premium-financed life insurance can be used to pay estate taxes, consider a successful business owner who is 45 years old, in excellent health and needs $10 million of permanent life insurance. (Note that a variety of legal strategies were employed to reduce his estate tax burden before life insurance was considered.)

One of his big concerns is cash flow. He would rather reinvest his firm’s profits back into the company, and is disinclined to sell the securities in his portfolio because they’re doing well and he expects that trend to continue.

If he were to purchase a $10 million life insurance policy, the premiums would be about $92,000 a year for the rest of his life. If he lived to 85, he would end up paying about $3.7 million for coverage!

Instead, he finances the premiums by borrowing a total of about $2.6 million from a third-party lender over six years. He pays only the interest on the loan—just $78,000 annually—for 15 years, totaling about $1.2 million. For the first six years of the policy, the business owner has to post some collateral (which, in this case, is part of his investment account).

After six years, the only collateral required is the cash built up in the policy. After 15 years, he uses the cash inside the life insurance policy to pay off the loan. At that time, the life insurance policy becomes self-supporting—the business owner has no more premium payments on his $10 million policy. In addition, there is now about $2 million of cash in the policy that he can access if needed.

Bonus: The policy’s cash is projected to continue to grow at a greater rate than the cost of the life insurance.

The upshot: He has secured his life insurance policy at a significant discount to what he would have spent if he had made traditional premium payments. This solution also offers the business owner an option for early payouts. He anticipates that in about 20 years, he will no longer need the $10 million of coverage because he intends to tax-efficiently transfer equity in his business to his adult children. If that proves to be the case, he can reduce the level of the life insurance and take money out of the policy—without having to pay any taxes on that money.

Next step

To discuss your estate planning needs or concerns, contact your legal or financial professional.

VFO Inner Circle Special Report

By Russ Alan Prince and John J. Bowen Jr.

? Copyright 2017 by AES Nation, LLC. All rights reserved.

No part of this publication may be reproduced or retransmitted in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, recording or any information storage retrieval system, without the prior written permission of the publisher. Unauthorized copying may subject violators to criminal penalties as well as liabilities for substantial monetary damages up to $100,000 per infringement, costs and attorneys’ fees.

This publication should not be utilized as a substitute for professional advice in specific situations. If legal, medical, accounting, financial, consulting, coaching or other professional advice is required, the services of the appropriate professional should be sought. Neither the authors nor the publisher may be held liable in any way for any interpretation or use of the information in this publication.

The authors will make recommendations for solutions for you to explore that are not our own. Any recommendation is always based on the authors’ research and experience.

The information contained herein is accurate to the best of the publisher’s and authors’ knowledge; however, the publisher and authors can accept no responsibility for the accuracy or completeness of such information or for loss or damage caused by any use thereof.

Unless otherwise noted, the source for all data cited regarding financial advisors in this report is CEG Worldwide, LLC. The source for all data cited regarding business owners and other professionals is AES Nation, LLC.

Securities offered through LPL Financial. Member FINRA / SIPC. Investment advisory services offered through NewEdge Advisors, LLC, a registered investment adviser. NewEdge Advisors, LLC and Congruent Wealth, LLC are separate entities from LPL Financial.