Life Insurance Premium Financing (LIPF)

Key Takeaways:

•  Significant life insurance payments can reduce liquidity and limit your ability to invest in the market or your business.

• With Life Insurance Premium Financing (LIPF), you can borrow up to 95% of the premium costs of your life insurance policy.

• Take advantage of financial arbitrage opportunities and pay back the loan with flexible options.

What is Life Insurance Premium Financing (LIPF)?

Life Insurance Premium Financing (LIPF) is a strategy where a policyholder borrows up to 95% of the premiums from a third-party lender, such as a bank.

In exchange for the loan, the policyholder typically assigns the policy, and cash value within the policy, to the lender as collateral. The loan is repaid in installments over time, or a policy loan, and in some cases, it can be repaid through the life insurance proceeds after the policyholder passes away.

While there’s an interest cost associated with borrowing, policyholders opt for premium financing because it frees up their capital for other investments. The policy owner and borrower have the possibility for a positive financial arbitrage, subject to loan interest rates and performance of the cash value investments inside the insurance policies.

In most cases the life insurance is used to pay estate taxes, fund buy/sell agreements between business partners and as a tax-efficient strategy to transfer wealth to another generation.
 

Benefits of LIPF

Life Insurance Premium Financing offers several key benefits for those seeking large life insurance policies without tying up their capital. Here’s how this strategy can help:

1.  Tax Efficiency: The structure of LIPF means that insurance proceeds are generally exempt from estate taxes, helping to preserve more of your wealth for your heirs.
   
2.  Asset Protection: By using LIPF, you can protect your heirs from the burden of having to sell assets to cover taxes or debts after your passing. Typically, the IRS requires estate taxes to be paid 9 months after death.
   
3. Financial Flexibility and Liquidity: LIPF allows you to finance up to 95% of the premiums, preserving your liquidity and freeing up capital for other investments or financial priorities.
4. Goal-Oriented Funding: The insurance proceeds from an LIPF policy can be used to fund a variety of needs based on your personal financial goals, from estate planning to business succession.
5. Flexible Loan Repayment: LIPF loans offer multiple repayment options, including using the policy’s accumulated cash value, a policy loan or even your regular cash flow. This flexibility allows you to tailor repayment based on your financial situation.

How it Works

Understanding the steps involved in Life Insurance Premium Financing helps you take full advantage of this strategy and make informed decisions. Work closely with an experienced advisor to make sure the process runs smoothly and aligns with your financial goals.

Here's an overview of the key steps:

• First, the life insurance policy is underwritten for the client. Importantly, the policy is not usually owned by the client for estate tax reasons. Instead, an Irrevocable Life Insurance Trust (ILIT) or a similar entity is created to hold the life insurance policy, ensuring the proceeds remain outside the client’s taxable estate.
• Second, the client works with a bank to set up the life insurance policy and establish any necessary collateral. This collateral secures the loan used for premium financing.
  
• Third, the bank finances the annual life insurance premiums and pays them directly to the insurance company on behalf of the trust. This allows the client to maintain coverage without making significant out-of-pocket payments.
• Fourth, the client (or the trustee) is responsible for making interest payments and, eventually, the principal of the loan, ensuring the loan is repaid over time.
• Finally, the strategy concludes with the payoff of the loan or the client’s passing. If the loan has not been repaid at the time of death, the life insurance proceeds are used to pay off the remaining balance, with excess funds going to the beneficiaries according to the trust's terms. If the loan is fully paid off prior to death, all of the life insurance proceeds are distributed to the beneficiaries tax-free, as outlined by the trust.
   

Potential Pitfalls

Life Insurance Premium Financing can be a valuable strategy, but there are several potential pitfalls to consider:

● Interest Rates: Fluctuating interest rates could increase the cost of borrowing over time, potentially making the financing less favorable than initially expected.

● Collateral Requirements: If the life insurance policy or other assets used as collateral lose value, you may need to provide additional collateral, which could strain your financial situation.

● Policy Performance: The life insurance policy’s cash value growth may not meet projections, leaving less money available to repay the loan and potentially creating a shortfall.

● Complexity: Premium financing can involve a lot of moving parts, from collateral management to interest rate fluctuations, making it a complex strategy that requires careful attention. Without the guidance of an experienced advisor and outside qualified estate, legal and tax professionals, these complexities can lead to costly mistakes or missed opportunities to optimize your strategy.

Interested in Learning How to Protect Your Loved Ones Without Sacrificing Liquidity?

Speak with a Comerica representative today. Our team of wealth professionals would be happy to review your life insurance goals and discuss whether Life Insurance Premium Financing is the right funding option for you. To talk through your needs and identify next steps, contact Todd Barfield, Regional Director at Comerica.