Financing of Life Insurance Premiums
Funding the insurance policy
As discussed in the section “Corporate vs.Personal Ownership of Life Insurance” an insurance policy can be owned by a company or personally. The premiums can be paid through personal income sources or assets, or if the policy is owned by a company, through its annual cash flow, dividend income or via the transfer of assets into the policy.
The “asset transfer” method of funding the premiums takes advantage of the tax-exempt investment opportunities within an over-funded Universal Life or Whole Life policy. In this “asset transfer” approach, tax-exposed investment assets are liquidated and the cash is transferred into the tax-exempt investment pool of the policy, such that the tax-sheltered income eventually pays the cost of the insurance. If the policy is owned corporately, all or a substantial portion of the death benefit will be credited to the Capital Dividend Account, thereby allowing the funds, that were previously “tax-trapped” inside the company, to be withdrawn on substantially a tax-free basis.
Another premium financing arrangement that has become more prevalent in the past few years is the use of bank leverage, which is available with a permanent cash value type of policy. For example, a whole life policy with cash values is an asset which can be leveraged against. However, a term-to-100 type of policy has no cash values and therefore cannot be bank financed.
There are a variety of leveraged premium funding models that utilize collateral loans from a bank or insurance company to replace investments that have been liquidated to fund the insurance premiums. These arrangements are typically structured to allow for the deduction of the interest payable on these loans. It is important that there be no direct dependency between the credited rate to the policy and the loan interest rate or the arrangement may fall under rules which limit the tax benefits of the arrangement.
Any type of leveraged life insurance arrangement requires thorough investigation, as well as legal, accounting and tax opinions as to its suitability. As a general rule, leveraged life insurance arrangements that assume the loan will continue over an extended period of time should be approached with great caution, as many of the assumptions that are initially used to model the arrangement will change over time.