Premium Financed Life Insurance
I would like to talk about an investment that I am very acquainted with through my wealthy investors. It is a product that uses leverage much like real estate to achieve asymmetric growth.
But I think what is most amazing about it is it allows people to put their money in vehicle that grows tax free and provides tax free income. And when these are set up correctly the investor can get tax free retirement income for the rest of their life in addition to protecting their estate from taxes when they die.
This product is life insurance but before you turn your nose up, I need you to understand until recently this product was only available for the very wealthy, people that had net worth of 50 + million. What you need to understand about the uber wealthy is they tend to find people who can engineer investments that meet their goals. And this product is a result of this idea. It has recently become available to accredited investors or people who have a high income or a net worth of one million. And it is really a game changer for this population to have access to such an incredible tool the wealthy and corporations have been using for years.
I featured it in chapter 9 my new book “Shattering Money Myths – How the Wealthy Invest” download here and it has been immensely popular with my readers to learn more about it. So, I thought I would dedicate a blog to it today.
The concept is called Premium Financed Life Insurance. It is a strategy where you can leverage a bank to purchase life insurance for you. Essentially, this is a loan that is used to buy a life insurance policy. The loan is secured by the cash surrender value of the life insurance policy and is offered by a third-party lender; such as, a private bank or a life insurance finance company.
Why? Well, I will go back to my real estate background. Most investors understand debt and that real estate for income is an arbitrage between debt and how much rents are generated. As an investor, liquidity can be a limiting factor when trying to start a cash-flowing insurance policy. Real estate investors have run into this problem, and premium financing is the solution. Why? Because you do not have to pay for the cash-flow insurance. The bank pays for it.
As I mentioned, premium financing is an advanced strategy that works for only the right people.
Who is the Premium Financing Strategy for?
Premium financing is a popular strategy for buying life insurance used by high-net-worth individuals, business owners, and entrepreneurs. By financing the majority of the upfront cost of the life insurance policy, high-net-worth individuals don’t have to cash in or sell assets to pay the entire upfront cost of a life insurance policy.
Most businesses have highly valuable key people who are vital to the company, and without them, it would suffer. Therefore, insuring the lives of key people is one way to protect the business. Instead of paying the full cost of insuring several key people, a business can finance the majority of this cost.
Premium financing a policy gives a business the protection it needs while providing the company with a cash-flow efficient method of funding the life policies of owners, executives, and/or essential employees.
How does Life Insurance Premium Financing Work?
Life insurance premium financing works by allowing you to take a loan to pay for most of the cost, known as the premium, to buy your life insurance policy. Private banks and premium financing life insurance lenders offer loans to high-net-worth individuals. The individual makes a down payment against the policy premium, and the lender pays the balance.
Most premium finance lenders offer interest-only loans and/or capital repayment at the end of the loan term. At the end of the initial loan period, a lender may provide you with a new credit facility (a pre-approved loan) based on the cash surrender value of your life policy.
What are the Benefits of Life Insurance Premium Financing?
Let’s look at our favorite reasons why premium financing a life policy makes sense:
Simply put, it’s using other people’s money to increase the investment returns of your life policy. This may sound high risk, but if you’re a homeowner, then chances are, you’re already using leverage by having a mortgage against your home, and this is a similar concept to fund your life insurance policy for more cash growth.
Here is a step-by-step guide showing you exactly why you should use leverage to buy your life policy if you can qualify for financing the premium.
#2 Keep your Cash Invested
Investments like property, shares, and bonds have medium to long-term term investment horizons. Selling those assets to buy a life insurance policy often doesn’t make sense. But a high-net-worth individual doesn’t have to cash in these assets and lose the potential for higher investment returns. They can keep their cash invested and premium finance their life policy instead.
By borrowing the majority of the upfront life insurance premium from a lender, your assets can stay invested, and you still get to buy your life insurance policy and the coverage that it provides.
Example of Leverage in a life policy:
If the upfront life policy costs $1M, then you would typically have to find the $1M to pay for it. But not with premium financing for life insurance.
A $1M premium may cost you only $100,000 to $200,000 (depending upon age, gender, where you live, etc.). Better yet, you would have 10 to 15 years to pay the $100k to $200k premium.
That means that the $800,000 that you didn’t spend buying your life policy stays invested and potentially earning higher returns than the cost of the interest you are paying on your premium finance loan.
That’s the benefit of Leverage. You borrow other people’s money to invest in the asset you want, exactly as you do with your home.
Let’s put that in perspective. What if you could buy a $1M commercial building, finance 80% to 90% of it, and you would have 10 to 15 years to make the down payment, all the while enjoying the cash flow, appreciation, and tax benefits of the investment. Sign me up!
Five times the growth in your life insurance policy sounds too good to be true, right? Wrong.
By using premium financing, your life insurance policy can achieve this level of return because you are borrowing to invest. You are leveraging. The expectation is that the growth in the life policy will be higher than your borrowing costs, meaning you will increase your investment returns.
Now let’s take a look at this example:
Buying a Life Insurance Policy with Finance
Using our example from earlier, if the life insurance policy you want to buy costs $1M, but you need to put down only 20%, then the plan will cost you only $200,000.
But even though you have put down only $200,000, you now have a life insurance policy with an investment value of $1M. You just borrowed the rest of the money.
Now, assuming the $1M invested in your life insurance policy grows by 5% in a year, your plan will be worth $1,050,000 after the first policy year, giving you investment growth of $50,000.
Now compare this to the investment returns you would have made without premium finance.
Buying a Life Insurance Policy Without Finance
You invest $200,000 in a life insurance policy. It has an investment value of $200,000 because you did not take advantage of leveraging through premium financing.
The $200,000 you invested grows by 5% in a year. Your policy will be worth $210,000 after the first policy year, giving you an investment return of $10,000.
Let’s compare the $10,000 return to the $50,000 return you could make if you premium financed your life policy. Obviously, premium financing brings a 5x higher investment return. That’s the benefit of leveraging your life insurance.
And it gets better.
#3 Maximizing coverage
Maximizing the amount of life coverage, you take out is important. The earlier you buy life coverage the cheaper it will be. Fact: Most households don’t have enough life insurance coverage.
But how do you get the life coverage you need WITHOUT paying for it all upfront? Premium financing allows you to buy far higher levels of life coverage because you are borrowing the money to pay for most of the upfront premium cost.
Here’s an example:
Life Coverage Without Finance
With our earlier case, a budget of $200,000 may buy you $600,000 of life coverage. Perhaps that’s enough, but perhaps not.
Life Coverage with Premium Finance
You invest $200,000 and finance the remaining $800,000, giving you total life coverage purchasing power of $1M.
By borrowing, you can afford to buy $3M of life coverage. That’s 5x the life coverage by financing your premium (5 x $600,000).
That’s an extra $2.4M of life insurance coverage.
That’s a massive increase in coverage and likely to be closer to what you want, or need, to protect your family or business partners as your wealth grows.
#4 Tax-free income
There are many ways to set up these policies, but we can structure a policy that targets a specific amount of future tax-free income; for example, from the ages of 65 to 90. We can solve for how much money needs to be contributed into the policy to achieve this and the results are very impressive. That the bank is largely funding this future income makes it that much sweeter.
Do I qualify?
In order to qualify for Premium Financed Life Insurance, you must be an “accredited investor,” which is defined as an individual with gross annual income exceeding $200k or joint annual income with a spouse exceeding $300k, or an individual whose net worth exceeds $1M, excluding the primary residence.
I am very skilled in this area and have a full understanding of how to set up this tax- efficient wealth building strategy. Depending on your current tax rate, it could help you achieve your goals much faster and with less risk than you are currently carrying. Please contact me to discuss.