How Wealthy People Protect Assets Without Disturbing Cash Flow

Shawn Plummer

CEO, The Annuity Expert

Simply put, premium financing is when an individual or business borrows money from a third-party lender, usually a bank, to pay the premiums on a life insurance policy.

How Do Wealthy Individuals Ensure That Their Assets Are Protected While Still Maintaining Positive Cash Flow?

You have achieved considerable wealth and assets, and you want to preserve and pass your estate to those who matter most. Now how do we protect it?  Premium Finance.

Life insurance is a foundation for a sound financial plan providing the protection you need to secure your legacy.

Premium financing has been used for years by individuals and entities to provide life insurance protection while minimizing current disruption to cash flow.

Policy owners have used premium financing for several reasons.

  • It enables the policy owner to acquire death benefit protection they might otherwise forego.
  • It significantly reduces the strain on current cash flow and working capital used to pay life insurance premiums.
  • It allows the use of leverage to transfer large amounts of wealth to heirs with minimal tax consequences.

The Concept

Premium Financing is not a type of life insurance policy.

It is also not a way to obtain “free” or “cheap” insurance.

Premium financing is a funding method that is sometimes used to help high-net-worth individuals with permanent life insurance needs.

Simply put, premium financing is when an individual or business borrows money from a third-party lender, usually a bank, to pay the premiums on a life insurance policy.

At some point in the future, the bank loan is repaid using policy cash values, life insurance death proceeds, other outside assets, or a combination of the above.

Maximizing Your Assets

With enough collateral, premium financing can allow you to purchase a life insurance policy by paying only interest and maintaining your other investments.

By paying the interest on a loan that covers the cost of a premium versus paying the premium itself, you retain capital you can deploy elsewhere using after-tax cash flow.

Premium financing benefits and considerations

Borrowing money to pay life insurance premiums has economic advantages and potential considerations, as is the case with any other loan or financial arrangement.

Key Benefits

Financing your life insurance premiums can deliver significant benefits.

It offers you the opportunity to:

  • Obtain a significant amount of life insurance with limited up-front out-of-pocket costs.
  • Preserve, maintain, and build assets in your existing portfolio by using third party funding to pay life insurance policy premiums.
  • Leverage your annual gift-tax exclusions or lifetime exemption to transfer other assets estate tax-free.
  • Minimize or eliminate gift taxes on policy premiums if the policy is owned by an Irrevocable Trust.
  • Gain an economic advantage by reducing the out-of-pocket cost of the policy and potentially leverage the future cash value.
  • Use the policy cash value as part of the collateral for the loan (additional collateral will be required to secure the loan).

Key Considerations

To make the most of your premium financing arrangement, there are potential considerations to know and monitor, such as the loan interest rate and policy crediting rate.

Keep in mind that:

  • Premium financing is a method of paying for life insurance that you need, not a reason to buy life insurance.
  • Loan interest rates can increase, which would result in higher loan interest payments than originally planned.
  • Policy credited rates can fluctuate, which may require additional collateral for a loan.
  • Lower than anticipated policy performance may require the need to borrow additional premiums to fund the policy.
  • You need to consult with your legal and tax advisors to understand potential tax implications, including estate, gift, and income tax.

Premium Finance Guidelines

Lending Requirements

  • U.S. currency financing (no foreign currency transactions)
  • The lender must be a recognized bank or financial institution and must be approved by us in advance (no asset-backed lending, hedge fund lending or venture capital lending)
  • All loan/financing documents must be submitted, including the proposed collateral assignment form and a bank term sheet (use of our collateral assignment form is preferred)
  • Bank loan must be full recourse and 100% collateralized
  • Bank loan interest should be paid annually
  • In some cases, full or partial interest accrual may be desired as part of the case design. Such an interest accrual is subject to individual consideration and evaluation.
  • Bank loan interest may not be paid from policy cash values during the first 10 years Summary Legacy Leveraging Guidelines
  • Basic and supplemental life insurance illustrations must use the current 1-year point-to-point illustration rate or lower
  • Interest sensitivity illustrations signed by the insured and owner
  • A supplemental stress test illustration signed by insured and the owner must be submitted that shows an increasing bank loan interest rate to the greater of 2% higher than the current bank offered lending rate or 6% by or within 10 years of projected policy issuance (must be signed before or at delivery).


To qualify for our premium financing program, the following criteria must be met:

  • You must have a minimum verifiable net worth of $5 million and a minimum verifiable annual income of $200,000
  • A documented insurance need (e.g.– estate tax liquidity, business succession, key person coverage, etc.) and clearly identifiable insurable interest
  • A specific trust or trustee may not be required by the lender, nor may the lender be affiliated with the trustee
  • U.S. based and located ownership is required if owned by a trust or business entity (no offshore trusts or non-U.S.- based entities). A non-U.S. resident may own the policy individually.

Examples of client situations that may be appropriate for premium financing include:

  • Personal liquidity issues or high opportunity costs exist: The majority of assets are in a closely held business or real estate project that are generating significant returns but limit the liquidity of you.
  • Gift tax minimization is desired: An estate tax funding need exists but the required insurance premiums are larger than the amount the clients are able to gift into the trust through their lifetime or annual gift tax exclusion amounts.
  • Business liquidity or financial statement concerns exist:
    • Business succession planning is needed but business liquidity is a concern;
    • Key person needs exist but company cash flow is not sufficient; or
    • A company desires to provide executive benefits that require significant cash outlays.

The purchase of insurance should not be secondary to the financing.

In other words, the transaction should not be entered into solely to take advantage of the difference between the loan interest rate and the policy’s crediting rate.

  • Total projected premiums may not exceed the client’s net worth
  • Interest payments cannot exceed 20% of annual gross income

Business-Owned Cases

Policies that are to be owned by a business and which insure executives and/or directors of the business will be underwritten and analyzed on a case-by-case basis, but in general, should meet the following specifications.

  1. The business must have a verifiable business valuation in excess of $10 million.
  2. Annual premiums may not exceed annual net revenues.
  3. Total premiums may not exceed the current verified business value.
  4. If the business owners are to be the insureds, then each business owner must meet the individual premium financing guidelines.
  5. For business-owned cases, insured non-owner employees must be a key employee.

Application Process For Premium Financing

  1. Find out your scenario is appropriate for premium financing.
  2. Complete a Fact Finder, and submit to the chosen Premium Finance company.
  3. The insurance company will go over the Fact Finder and clarify any questions or objectives.
  4. Then the insurance company will create a case design.
  5. You may establish an irrevocable life insurance trust to own the policy outside of the estate of the insured/grantor. (If the client is a business, the client will own the policy.)
  6. You fill out a life insurance policy application, sign a Premium Financing Disclosure form, and submit to the insurance company.
  7. You’ll complete a bank application and provide the required financial information.
  8. We will respond with an underwriting offer. If the offer is different than the underwriting classification illustrated, new illustrations must be completed and the financing application must be amended to meet the new premium requirements.
  9. The lender makes a loan offer and you will sign the loan documents, including a collateral assignment form.
  10. You’ll then sign the final basic illustration and premium financing supplemental illustrations and Disclosure Statement and returns the signed documents to the insurance company.
  11. The lender pays the first year premium to the insurance company and the policy is issued.
  12. We’ll deliver the policy to the owner according to the policy delivery procedures.
  13. Future premium billing notices are sent to the policy owner (typically a trustee or a business entity) as well as the lender. The lender then pays future premiums, according to the financing agreement.


At all times during the life of the loan, the borrower must have pledged sufficient collateral to fully (100%) collateralize the loan.

The main source of collateral will be policy cash values.

In most cases, the life insurance policy will not provide enough value to secure the loan, and other collateral will be required.

This is typical in the early years of the transaction. Still, as cash values grow, the need for additional collateral is normally expected, but not guaranteed, to decrease and eventually be eliminated.

Lenders generally only accept liquid collateral and will normally have the right to liquidate it at any time without the consent of the borrower if the borrower is in default.

Depending on the type and liquidity of collateral provided, the lender may discount the collateral to consider possible price fluctuations.

Examples of collateral normally accepted:

  • Letter of Credit issued by a large financial institution 
  • Certificate of Deposit (CD)
  • Cash equivalents
  • Marketable securities
  • Bonds
  • Other life insurance policies

Approximately 45-60 days in advance of the policy anniversary, the lender will typically request a statement reflecting the low point of the policy’s guaranteed cash surrender value for the 1-year period following the policy’s anniversary date.

If this amount is not sufficient to fully collateralize the loan for the same period, additional collateral will be required.

The lender will typically notify the policy owner of any collateral shortfall before the policy’s anniversary date.

When the lender has a collateral assignment on the policy, all ownership rights associated with the policy rest with the assignee, except the right to designate a beneficiary, until the assignment is released.

At the time the assignment is released, all rights revert to the owner of the policy.

Ownership rights held by the assignee include, but are not limited to, the right to borrow against the policy, the right to surrender the policy, or the right to change the death benefit option under the terms of the policy. 

Loan Acceleration Events

Loan acceleration events are specified in the lending documents.

If a loan acceleration event occurs, the lender has the right to call all loans made as fully due and payable under the terms of the loan documents.

The loan acceleration will have no bearing on the life insurance policy, and premiums continue to be required to keep the policy in force.

If an alternative lender cannot be found, the policy will potentially lapse if premiums are not paid to the insurance company to keep the policy in force.

Transaction Costs

Various transaction costs are incurred to complete a premium financing case.

These transaction costs include but are not limited to loan origination fees, accounting fees, legal fees, the cost of carrying additional collateral, and other costs.

The deductibility of these transaction costs will depend upon the client’s specific situation, but generally, these costs are nondeductible.

All questions regarding the deductibility of these fees/expenses should be addressed by an independent legal counsel and/or CPA before making any decision regarding the federal income tax consequences of the proposed transaction.

Case Designs

Premium financing generally entails overfunding the policy, i.e., maximizing the premium per dollar of the death benefit to repay the bank loan out of policy cash values while leaving sufficient cash value to keep the policy in force.

Although there is no predetermined premium pattern required, the funding strategy might be tailored after one of the following two scenarios:

Maximum Funding 

Under this strategy, the policyholder would pay the maximum amount of premium allowable without creating a modified endowment contract.

An increasing or return of premium death benefit option will provide the necessary increase in face amount to accommodate the increasing loan.

This also provides the maximum cash value growth while avoiding modified endowment contract status.

At the end of the loan term, a policy loan or withdrawal would be taken from the policy to repay the loan principal while leaving sufficient cash value to carry the policy forward without additional premium outlays.

To the extent that cash values, based upon actual performance, would be insufficient to repay the loan completely while leaving enough cash in the contract to fund the ultimate death benefit, the insured would supplement the bank loan repayment with outside cash.

10-Year Premium Method

In this scenario, the policy owner models the policy to pay level premiums over a 10-year period of time in amounts sufficient to carry the policy forward without additional outlays thereafter.

The premiums would be borrowed, and after 10 years, the loan would be paid off entirely through outside cash resources, through policy cash values, or a combination of both.

This scenario is commonly used in conjunction with other estate planning techniques such as Grantor Retained Annuity Trusts (“GRATs”) or Defective Trust Sales. 

Risks and Considerations

Premium financing is not for every case, and it is not without risk.

Risks are inherent in the process, especially the longer the loan stays outstanding.

Fluctuations in interest rates, policy performance, client financial condition, or lending requirements may impact the premium financing results.

Thus, proper case design with built-in flexibility and risk minimization is critical.

This customized premium financing approach is designed to assist you with the opportunity to make a well-informed decision.

You should fully understand all risks associated with premium financing, including:

  • The policy will serve as the primary source of collateral for outstanding loans under the transaction and other collateral may be required by the lender to supplement any shortfall in policy values
  • Fluctuations in policy crediting rates and bank loan rates may result in negative arbitrage at various points in time and may result in policy growth not keeping pace with the loan growth
  • Premium financing should not be entered into purely as an arbitrage method.
  • Additional out-of-pocket funds may be needed to continue the life insurance and prevent the policy from lapsing
  • A rollout strategy should be utilized in the event market rates become unfavorable
  • Borrowing may reduce the net death benefit to the beneficiaries
  • Bank loans may be callable under certain circumstances
  • Interest rate risk is inherent in this program. The client should evaluate his or her risk tolerance level when considering a premium financed transaction.
  • The proceeds and the cash surrender value of the life insurance policy are assigned to the lender
  • Access to cash values is restricted and may not be accessed without lender permission

You should be represented by independent legal and/or tax counsel who can review and evaluate the merits of the premium financing method.

The premium financing disclosure form should be discussed and reviewed by counsel.

Rollout Strategies

Each policy owner needs a premium loan repayment plan or rollout strategy.

There are several rollout strategies available to the policy owner.

  • From policy values
  • From policy owners’ available cash or liquidation of other assets
  • A combination of policy values and outside assets
  • Additional estate planning methods that transfer assets to the trust

The use of outside assets in later years could trigger gift tax issues if the assets have contributed to the ILIT from the insured.

The use of annual exclusion gifts to the ILIT to form a side fund inside the ILIT can alleviate these potential future gift tax concerns.

Annual Review

There should be an annual review conducted every year.

This review should cover the collateral position for the upcoming year, potential rollout strategies in later years, and compare actual values at the end of the year to projected values at the beginning of the year.

The lender will normally monitor the sufficiency of the collateral annually.

If the beginning and end-of-year values are different, adjustments to out-of-pocket interest payments or loan amounts should be considered to provide the best chance for long-term success.

Other Considerations

Deductibility of Bank Loan Interest

A common issue raised by debt-financed transactions is whether the interest incurred to carry the loan is deductible for federal income tax purposes.

Sections 163 and 264 of the Internal Revenue Code (IRC) determine interest expense income tax consequences.

IRC Section 163(h)(1) provides that no deduction is allowed for personal interest paid or accrued during the tax year.

Therefore, loans incurred by the policy owner to purchase a life insurance policy are considered personal interest for which no federal income tax deduction is allowed.

Section 163 does provide an interest deduction for interest paid or accrued concerning certain indebtedness incurred in an active trade or business.

However, this deduction is limited to the income generated by the investment.

Additionally, IRC 264(a) (4) denies a deduction for interest paid or accrued on the purchase of a life insurance policy by the taxpayer covering the life of any individual.

These two sections (163 and 264) make clear the intent of the IRC not to allow interest deductions on debt-financed transactions entered into to purchase life insurance.

I’m not an Accountant.  This content is for informational purposes only.  

Gift Taxes

The purchase of large life insurance policies typically involves a trust or other entity owning the policy to avoid having the policy included in the insured’s gross taxable estate.

These transactions usually involve the use of an irrevocable life insurance trust (ILIT).

Because a legally independent third party owns the policy, the premium payer must gift the life insurance premiums to the ILIT so the ILIT can pay the premiums.

Depending upon the size of the policy, this could involve making significant taxable gifts above the current annual exclusion amount.

Premium financing significantly reduces the size of the taxable gifts necessary to fund an ILIT-owned policy because loans made to an ILIT are not taxable gifts.

However, the interest due on the indebtedness will be treated as a taxable gift if the grantor of the ILIT pays the interest or contributes money to the ILIT for the trustee to pay the interest.

Where the donor of an ILIT-owned policy guarantees the loan, there is concern that the value of the guarantee constitutes a gift by the donor.

I’m not a tax professional.  This content is for informational purposes only.  Gift Taxes are very complex, so please seek legal and tax counsel.

Estate Taxes

Life insurance proceeds are includable in the insured’s estate if the insured owns the policy or possesses any incidents of ownership in the policy.

If the insured’s estate is the policy beneficiary, the policy proceeds will be included in the insured’s gross estate.

When an entity such as an ILIT is the policy owner, there is typically no estate tax inclusion.

However, even with an ILIT-owned policy, the insured must be careful to avoid keeping any incidents of ownership to the policy.

Such retained incidents include:

  • the right to name the beneficiary of the death benefit,
  • the right to change the beneficiary,
  • the right to borrow the cash value of the policy,
  • the right to change coverage under the policy,
  • the right to convert the form of coverage or to elect the use of a rider.

Any of these rights could result in the life insurance proceeds being included in the insured’s estate. 

Properly structured ILITs are set up so that an independent trustee holds all of these rights and must act in a fiduciary capacity for the beneficiaries in exercising these rights.

Section 2035 of the IRC provides that if a taxpayer transfers property or an interest in the property and then subsequently dies within three years of the date of the transfer, the property will be brought back into the gross estate of the decedent.

Therefore, an insured must survive at least three years beyond a transfer of ownership of a life insurance policy to escape estate taxation.

It is generally recommended that, when possible, the ILIT purchase the policy from the outset to avoid Section 2035 issues.

I’m not a tax professional.  This content is for informational purposes only.  Estate Taxes are very complex, so please seek legal and tax counsel.

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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