The Surprising Versatility of Premium Financed Life Insurance
If you are facing the challenge of paying high insurance premiums to protect your family’s financial future, you may want to consider the advantages of Premium Financed Life Insurance, a strategy that is new to many medical professionals.
An increasing number of doctors each year are finding that a properly leveraged and structured Index Universal Life plan is a cost-effective way to obtain and own a sufficient amount of life insurance. This strategy can be especially advantageous if you have an illiquid estate, and do not want to pay the high premiums required immediately out-of-pocket.
This approach is not for everyone, but it may be for you considering the following advantages:
• It offers permanent insurance at a fraction of the out-of-pocket cost, freeing up your money for other investments.
• Depending on your location and particular situation it may offer asset protection.
• If structured and funded properly, it could offer you tax-free income for life.
• Depending on your situation, the interest payments may be tax-advantaged.
• Does the following conversation sound familiar to you…?
“Life insurance premiums are just too high for what I need,” laments Dr. Carolina Hong, a 45 year-old cardiologist, shaking her head.
“The premiums are high,” responds Dr. Joseph Percival, a 56 year-old neurologist. “You know, I found a way to get the same coverage for a fraction of the out-of-pocket cost.”
Dr. Hong looks at him closely, “I’m listening.”
Dr. Percival continued, “I was paying premiums of $97,506 per year for life, for 10 million dollars in death benefit. It was a huge expense, but I have to cover my family, my twin girls are 12 years old now.”
“I found a way to get the same coverage for only $55,000 per year, for just 15 years, and my wife and girls will be covered for the rest of my life. That allows me to keep my money freed up to invest elsewhere since I chose to finance my premium payments.”
Dr. Hong leaned forward, “What if I need life insurance to cover my business partner in case I die before him, or vice versa? Would this work for me?”
Dr. Percival nodded, “It may be ideal for that scenario.” Dr. Hong raised her eyebrows, thinking, why haven’t I heard about this before? “Tell me more.”
What Dr. Percival is talking about is Index Universal Life with leveraged premiums…
So, how does it work?
Life Insurance Basics
• Guaranteed Universal Life (GUL): Offers a level benefit and level premiums for your entire life. It has modest, guaranteed growth. For Example: Dr.Percival, 56 years old, buys $10 million in death benefit, at $97,506 per year.
At age 90 he would have paid $3,412,710 for $10 million in death benefit. If he stops paying premiums, the coverage stops, with no cash value in the policy.
• Variable Universal Life (VUL): Has a cash value component subject to the market vagaries in which it is invested, including downside losses.
• Index Universal Life (IUL): Offers a growing death benefit and increasing cash value, depending on structure and funding. Linked to an index, such as the S&P 500, with a floor and sometimes a cap. Your money within the IUL participates when the index rises, but you don’t lose money when the index falls.
Key Benefits of the IUL:
• When funded and structured correctly to meet IRS guidelines, the cash value within an Index Universal Life policy grows tax-deferred, to create a lifetime of retirement income from which you can borrow.
• Cash value gains are locked in each year (withdrawals and loans will reduce both the policy’s death benefit and cash value).
• Access funds penalty-free before 59 ½, no required distributions at age 70½.
• The money you borrow from the policy still has the ability to earn interest within the policy.
FAQs For Financing IUL Policies
1. How Can You Finance IUL Premiums?
If Dr. Percival, a 56 year-old male buys $10 million in death benefit in an IUL policy using financed premiums.
Instead of paying the entire premium out-of-pocket, he pays $55,000 yearly towards the interest for 15 years on the loan, for a total of $825,000.
Assuming a 7% average yearly increase of the index (with the first two years estimated at 0% to be conservative) in year 20, the cash value in his life insurance policy has accumulated enough value to pay off the premium loans.
He now has a $10 million death benefit that could continue to grow, coupled with potentially tax-advantaged income for life.
2. What is the opportunity cost of paying premiums out-of-pocket vs. premium financing?
Dr. Percival realized that paying premiums in a Whole Life policy to age 90 would total $3,412,710, so he chose to finance an Index Universal Life policy. His total cost for financing would be $834,147. This is a savings of $2,578,563.
He now has that money to invest elsewhere. For example, assume he invested the money he saved on premiums, and he earned a projected 7% annual rate of return until age 90, he could earn an additional $8,623,256.
3. How does premium financing work?
There are two main parts to an Index Universal Life product with premium financing: the life insurance and the loan. This is how they work together in a hypothetical example.
In the example above Dr. Percival needs $10 million of life insurance coverage and takes the following steps:
• He goes through health and financial underwriting.
• His advisor finds the best possible lender and lending structure
• His advisor shows him how the cash value in the policy can be used as partial collateral for the loan.
• He posts the remaining collateral (if required) with a letter of credit from his bank.
Paying off the loan with the proceeds from the policy:
In this example, the accrued loan amount is paid off in year 20 by a loan from the cash value of the IUL.
What’s the risk? Simply put, you want the policy cash values to outpace the accrued premium loan interest. Use reasonable expectations in your forecast (illustration) with regards to the interest income and the loan interest.
Premium Finance may be the solution you are looking for if you:
• Require personal insurance and don’t want to pay the high premiums
• Require business insurance such as a Buy-Sell Agreement, Key Man policy, etc
• Seek to minimize gift tax exposure
• Are looking for ways to meet wealth transfer objectives
• Need life insurance for estate tax, estate equalization, or liquidity
• Would benefit from the possibility of tax advantaged interest payments