What is Premium Finance Life Insurance?

Premium finance is a sophisticated strategy in which policyowners pay substantial life insurance premiums by borrowing from a third-party lender, allowing them to preserve their own capital for other investments or opportunities. Similar to how high-net-worth individuals leverage favorable loan terms to acquire real estate, they often secure preferential financing arrangements to purchase large life insurance policies, avoiding significant out-of-pocket premium payments.

Typically, the policyowner repays these premium finance loans through regular payments, though some may choose to roll up or capitalize the interest, banking on the expectation that the cash value growth of the life insurance policy will outpace the loan’s accruing interest. This approach can provide enhanced financial flexibility while maintaining significant life insurance coverage that can support estate planning, wealth transfer, or business continuity goals.

However, it’s important to note that premium financing comes with its own risks and responsibilities. Borrowers are required to post collateral whenever the cash surrender value of the life insurance policy falls short of the outstanding loan balance. Additionally, changes in interest rates, policy performance, or economic conditions can influence the overall cost and viability of this strategy. Despite these considerations, when structured and managed carefully, premium finance can serve as a powerful tool for wealth preservation, tax efficiency, and estate planning, helping affluent individuals meet their financial goals while maximizing the benefits of their life insurance policies.

Why use Premium Financing?

Simply put, the leverage available from premium financed life insurance allows policyowners to acquire substantially more life insurance for a small fraction of the cash flow outlay normally needed to support that size of a policy. This not only allows them to keep other assets performing elsewhere, but it often produces a very attractive tax-free IRR (internal rate of return) for a relatively nominal out-of-pocket cost.

The ideal plan for most premium financed life insurance strategies is that the low-interest payments to borrow these massive early premium payments create a compounding snowball of cash value growth. Over time, this compounding effect can significantly amplify the value of the policy, making it a powerful tool for both wealth preservation and legacy planning.

If the cash value compounding surpasses the extremely low hurdle rate of the premium financing, the policy itself can absorb the loan using its built-in policy loan feature. This can eliminate the debt entirely while leaving the policyowner with a substantial windfall. These future policy distributions offer incredible flexibility, whether in the form of supplemental tax-exempt retirement income, a tax-free death benefit for heirs, or both.

Additionally, premium financed life insurance provides an opportunity for high-net-worth individuals to enhance their overall financial strategy by integrating tax-efficient wealth transfer and asset protection. By carefully structuring the policy and financing arrangement, it’s possible to achieve significant financial leverage while minimizing risks, making it an attractive option for those seeking long-term financial security and legacy-building opportunities.

Most Premium Finance Clients fall into these categories:

1. For wealthy families whose asset base is largely illiquid (real estate or closely held business interests), premium finance can be an ideal option to help them expand their personal estate planning without upsetting the apple cart.
2. Many high net worth individuals have been using premium financed life insurance as a synthetic ROTH of sorts since actual ROTH IRAs have low contribution limits and even prohibit high-income earners from contributing. The leverage available from premium finance also offers appeal since over the last 25 years there has been a favorable spread between the low borrowing rate and the potential for cash value growth within the policies.
3. For established businesses that need to maintain a strong balance sheet to acquire certain contracts, bonding, or other loans to keep their operations intact, premium financing allows them to acquire key person protection for invaluable employees or to shore up buy-sell agreements amongst the owners. More recently we are also seeing businesses and even universities set up “golden handcuff” retirement programs for highly paid employees whom they wish to retain and reward.

How Premium Finance Life Insurance Works

Typically, a high net worth individual (or his/her ILIT trust or business) applies for copious amounts of life insurance for estate planning or retirement planning. The life insurance policies will largely be Indexed Universal Life (IUL) or Whole Life insurance since lenders recognize that these types of policies are quite stable and can therefore offer a very high loan-to-value ratio of 90% or higher.

The premium financed life insurance policies will most often be funded with the maximum allowable premium during the first 4-7 years to achieve high early cash value as well as strong long-term performance.

The Benefits of Premium Finance Life Insurance while Living

The main benefit of premium financed life insurance is the ability to acquire substantially more life insurance for a significantly lower cash flow outlay. Keep in mind though that premium finance will of course look great when showing today’s favorable spread as a constant that compounds favorably for decades into the future. Quite simply, a properly-structured premium financed life insurance strategy allows you to potentially earn copious amounts of tax-exempt interest on an increasing cash value balance while paying simple interest on a flat balance (once all premiums have been borrowed).

Six Main Benefits Premium Finance Life Insurance Provides Individuals:

1. Replaces the need for paying wasteful term insurance premiums typical of high-income earners during working years.
2. Substantially more cash value compounding in your favor (even if encumbered by the premium finance loan).
3. The ability to keep your other liquid and illiquid assets deployed elsewhere.
4. Potential for positive arbitrage between the policy’s cash value growth rate and premium financed loan rate (obviously dependent on actual performance).
5. Potential for supplemental tax-exempt retirement distributions that would be immune from your highest and most penal tax brackets.
6. And/or the existence of a tax-free death benefit outside the estate, which allows the insured to tactically spend down less tax-efficient assets in their estate during their lifetime as well as the ability to utilize other more complex estate planning strategies (all dependent on additional estate planning).