Question: I want to purchase life insurance but do not want to liquidate my personal portfolio of securities to pay the premiums. Any suggestions for how I can accomplish this?
Answer: You should consider borrowing money to purchase the policy. Financing insurance premiums for life insurance purposes is an increasingly popular technique. Many individuals contemplating life insurance purchases are reluctant to liquidate investments to generate cash for the payment of premiums and thereby make the bad choice of not buying needed insurance. Utilizing a third-party lender to finance premiums allows a prospective insured to purchase a policy with borrowed funds, thereby leaving portfolio assets intact for future growth and income. Furthermore, by not liquidating portfolio investments, insurance can be purchased without incurring the income tax cost that might arise on the sale of appreciated portfolio assets. Today’s historically low interest rates make this strategy even more beneficial.
In a typical premium financing arrangement, an insured creates a trust which becomes the owner of a life insurance policy on his or her life. The trust arrangement is necessary so that the policy proceeds will not be subject to estate taxes when the insured dies. The policy must be a whole life insurance policy or some other type of policy that has a cash value component; a term life insurance policy that has no cash buildup within the policy will not provide sufficient collateral for the lender. A bank or other institution will loan funds to the trust for the payment of policy premiums. The trust will pledge the policy to the bank to secure the premium advances although other collateral may be required depending upon the lender. The trust must pay the interest charges on an annual or more frequent basis to the bank, but the interest payments on the outstanding loan will be far less than the premium payments. After a sufficient number of years have lapsed and there is a meaningful amount of cash value accumulated in the policy, the trust can borrow or otherwise withdraw cash from the policy and use the funds received to repay the lender. The policy will continue in force and the policy proceeds will be payable upon the insured’s death. The insured will essentially have financed insurance payments and only paid interest charges to purchase and obtain the policy without liquidating investment assets for premium payments.
A classic third-party premium financing arrangement is generally available only to individuals who are purchasing significant amounts of insurance on their lives. A variation of this technique, however, can work for those individuals who are not purchasing a sufficient amount of insurance to interest a third-party lender. Persons such as yourself with a portfolio of securities can take a margin loan from an investment portfolio and essentially self-finance the premiums by loaning the funds needed for premium payments to the trust. With the relatively strong market performance of late and low interest rates, an individual can obtain coverage without liquidating portfolio assets just as if a third party lender was involved.
Regardless of which variation of premium financing arrangement you utilize, there are risks to be considered. A rise in interest rates can increase the financing cost making it more expensive to finance the premium payments. Similarly, a meaningful decrease in the value of your portfolio assets could require more capital to be contributed to the portfolio to sustain an existing margin loan. Problems may also arise if the policy does not perform as expected and the lender cannot be repaid as originally scheduled.
Whether your needs are creating funds to pay estate taxes, funding a buyout of a closely held business upon death or simply satisfying liquidity needs for your family, life insurance is a desirable vehicle to accomplish your objectives. A properly structured financing arrangement can provide a would be insured with a source of funds for premium payments without having to utilize other assets for premium payments.
The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfbbg.com.
