Premium financing is a financial tool that many high-net-worth individuals are taking advantage of to secure coverage and protection for their estates. This approach can be quite intricate, as there are endless scenarios for structuring a life insurance premium financing policy, so it is important to implement this complex strategy with a trusted and experienced financial professional.
In this episode of Money Script Monday, Luke explains how to use Premium Financing as an essential tool in your overall estate planning strategy.
Click on the whiteboard image above to open a high-resolution version of it!
Hello. My name is Luke Geller. And welcome to another episode of Money Script Monday.
Today we're going to be talking about premium finance made simple.
Now premium finance is definitely not a simple concept and it can be very confusing.
But what I want to do is try and break it down and explain the benefits and really make it as simple as possible for you to understand how it can work with you and for you in your estate planning needs.
All right, so what we're going to talk about as we're actually going to talk about premium finance for your estate planning, then we're going to look at some pros and cons.
Finally, we're going to look at kind of an example of a $10-million estate tax bill that could be out there.
The reason that that premium finance is so important to talk about right now is because we're in a great environment for it.
What I mean by that is interest rates are extremely low and we don't know where estate taxes are going to go in the future.
They are extremely beneficial for the client right now but who knows how long that is going to last.
So, if you think that you might pass away and you have an estate that might have an estate tax problem and you pass away now, it's more beneficial for that.
However, if you plan on living in another 10, 15, 20 years, who knows where that could go and what the estate tax bill to your estate could be.
Financing for Estate Planning
Let's go ahead and break down what financing for estate planning really comes down to.
In this diagram here, it really breaks it down really well. So, I want you to think of four different components:
- Insurance Company
The trust is outside of the client's estate in the form of an irrevocable life insurance trust.
What the client does is the client has to prove collateral or prove that they qualify for the loan to the bank.
Then the bank pays those premiums to the insurance company for the life insurance policy.
That death benefit gets distributed to the trust once the client does pass away.
The trust then pays off the loan to the bank and any interest on that loan and anything in excess goes to the trust and to the client's beneficiaries that are named in that trust.
Now, I just went through that extremely quickly and try to make it as simple as possible for you.
There are a couple of different levers that can happen.
In most cases, and pretty much in every case these days, there's also one other thing that you want to keep in mind is that the client is actually going to be paying some of those interest payments to the trust in the form of gifting.
The client's going to gift money to the trust to help pay off interest to the bank as well.
The client is proving collateral, proving they qualify for the loan, they're also paying interest payments to the trust.
The trust is paying those interest payments to the bank, the bank is paying premiums to the life insurance company, and then a life insurance company pays the trust out the death benefit.
The trust will pay the bank off for the loan and everything else goes to the beneficiaries.
So, what's the benefit of finance? Why would you go through all this trouble?
Well, let's take a look at some of the pros and cons.
Pros and Cons
At first you have, it's a much lower out-of-pocket expense when you finance those premiums.
Just like you can buy a house you can buy a $700,000- or million-dollar home or you can finance that home over a 30-year period.
There's a lot lower out of pocket cost for you starting day one.
Now, on top of that, you're also maximizing your gift and estate tax planning strategies.
If you remember the diagram that we just went through. We have that irrevocable life insurance trust outside of the estate.
That ILIT owns that policy. When the insured passes away, the insurance company pays that death benefit to the ILIT outside of the estate and that ILIT pays off any estate taxes.
It's a way to maximize your estate planning strategies. And on top of that, when you're financing your premiums, you're again saving out-of-pocket costs.
When you gift those premiums or those interest payments to the trust, it's much less than it would be if you're paying completely out of pocket.
Then finally, you're not tying up existing capital.
Again, if you're paying much more for premiums, you're paying completely out of pocket for premiums.
Then you're tying up potentially $100, $200, $300,000 that you would be paying and life insurance premiums instead of paying the interest for that loan.
So, those are some strong pros for this strategy.
Let's take a look at some of the cons. These are important things that you need to remember.
It's tied to policy performance. What your interest payment might be or your collateral requirements might be.
If the policy underperforms you might have to pay interest a little bit longer, you might have to put up a little bit more collateral.
Those are things that you want to keep in mind.
Every time you look at a premium financing plan or premium financing strategy, it should come with kind of a worst case scenario or a stress test.
Just make sure you look at that, understand that you might have some higher requirements and some higher needs that come if the policy doesn't perform or if interest rates rise.
If interest rates rise, right now we're an extremely low interest rate environment, it's extremely friendly for this, but if they rise, then that interest payment could rise as well.
Again, any illustration you look at should show interest rates increasing over time as well.
Loan renewal is extremely important.
Each year you're going to have to renew that loan and so you want to make sure you stay on top of it because it is extremely important.
You just want to make sure they have everything taken care of and it doesn't stress you out.
The reason you have this policy is to make sure you're staying as least stressful as possible.
So, making sure you take care of that loan renewal is extremely important.
Now finally is collateral requirements. We talked about it a little bit is that there are going to be some collateral requirements for the loan.
Now the great thing about using life insurance or index universal life is that it builds up cash value and you can use that cash value for collateral.
Banks actually love premium financing because that cash value build up in the policy is used as collateral, so it's not as risky of a loan for them in that sense.
$10MM Estate Tax Bill
Let's take a look at an actual example of a $10-million estate tax bill.
What that means is that out of your estate, $10 million is owed to the government.
After all the exemptions that for everything, this state would still owe $10 million.
This client, his hard work, his basically life's work of building up his estate, now $10 million of that work has to go to the government to pay these estate tax bills.
Has to go to Uncle Sam because of where we are at in debt and just because of the estate tax that is out there.
Let's go over three different ways that that estate can pay for that bill. So we're going to actually start with option three down here.
The estate could pay the full $10-million bill.
If there is no planning done then the estate would have to pay a full $10 million.
And your beneficiaries might have to sell off assets, might have to sell off properties, businesses, whatever they have to do to get that $10 million.
That's the cost to the estate. That's not very great.
Let's take a look at option two.
Option two is there was some estate planning done and you bought a life insurance policy inside of an ILIT and that life insurance policy was a $10 million policy where the premiums were $250,000 for 10 years.
It's guaranteed it's a guaranteed policy to age 120, you want it to be safe, make sure you had everything.
That costs the estate $2.5 million. Now, we just lowered your cost to the estate for your estate taxes from 10 million down to 2.5 million.
That's a huge benefit. That's great for the estate, that's great for your beneficiaries that they don't have to worry or have this burden.
Let's see what else we can do.
In the power of financing and option one, now we still get that $10 million policy but instead of paying $250,000 for it, we're actually borrowing money from a bank for those premiums or paying interest of $70,000 over 10 years for a total of $700,000.
Now we just reduced that cost to the estate for estate taxes from $10 million by less than one 10th down to $700,000 of a cost to the estate.
That is a huge amount of savings for your estate, for your beneficiaries, and for your hard work that spent your life doing.
I hope that today you were able to look at premium finance and understand the benefits to doing some estate planning.
Looking into the future and making sure that your beneficiaries, your estate is taken care of and ways to do that cost-effectively.
Again, this is a great environment to do so.
So please, I ask you if this is something that you're looking into, I highly recommend talking to someone about it and going through some of the things that we talked about today.
Hope you have a great day and we'll see you next time.