The Value of Life Insurance Premium Financing in Estate Growth Planning

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April 29, 2016


It's easy to get caught up in the day-to-day demands of life — from running a business or managing investments to balancing work, family and play — and all too easy to put off longer-term needs such as estate planning. But failing to make difficult financial decisions now can affect your survivors long after you’re gone. Thinking long term can help your survivors avoid many challenges, including a tax bill that they might have to settle, which may mean quickly selling off property or unwinding the family business.

 

For 2016, the federal estate tax exemption is $5.45 million per individual or $10.9 million for a married couple. Anything above that threshold will be taxed. Additionally, some states levy their own estate or inheritance taxes — anywhere from 15 to 20 percent. Families are often surprised to learn that tax is due within nine months of a death.

“Some advisors tend to just look at the numbers and say, for instance, ‘You’re worth $15 million, and the exemption is $10 million, so the taxes will be $2 million, and your kids will get $13 million,’” says John Melvin, Wealth Management Consultant for The Private Client Reserve in Kansas City, Kansas.

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April 29, 2016


But Melvin says it’s important to take the conversation a step further: “I say, ‘Here’s your balance sheet. Where would your kids go to get the $2 million for taxes?’ Then you see them grimace.”

 

Using Life Insurance to Pay Estate Taxes

 

One option for people with large, but illiquid, estates is to set up a life insurance policy with a plan to have the proceeds used to pay estate taxes. This allows your survivors to manage assets in an orderly way.

 

Planning for Your Family’s Future

 

For instance, families forced to sell assets on short notice might have to contend with a declining market or buyers in search of a deal. “When people find out that some- one died and that there are 10 pieces of real estate worth $500 million and the family has tosell them — that could easily be a fire sale,” Melvin says. 

On the other hand, if surviving family members have life insurance proceeds available to pay estate taxes, they can take their time selling other assets, if that’s the direction they decide to go.

 

Additionally, if you own a family business, it might be necessary to have a reserve of cash that can cover an interruption in management, legal work and other expenses after you die, says Paul Loux, Regional Credit Manager for U.S. Bank in Denver. Life insurance can take care of those needs through the transition period.

 

The U.S. tax code allows you to establish an irrevocable life insurance trust to hold an insurance policy, removing it from your estate. The trust protects the cash value of your life insurance and reduces your estate tax liability, Loux explains. If you buy a universal life policy — a type of permanent insurance — a portion of the premiums paid toward that policy become an asset that will accumulate and earn income over time. This can serve to reduce the overall cost of insurance or enhance the death benefit available.

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April 29, 2016


Financing Life Insurance Premiums

 

For a large estate, life insurance premiums can easily exceed $1 million a year. Brad Scott, Market Leader for The Private Client Reserve in Kansas City, points out that it can be inconvenient or challenging for those whose assets are tied up in a family business, or for entrepreneurs moving from one startup to the next, to free up cash to make those payments. That’s where premium financing comes in. Some banks will lend money to a client for the premiums, preserving the client’s cash flow for more attractive investments.

 

“Some of the most significant life insurance policies in the country are written with premium financing,” Scott says. “Many people with a large net worth have the money invested in their businesses, and they’re getting a nice return. They don’t want to use that money to pay the premiums for the life insurance they need.”

Those who choose to finance their premiums work with their lender to create a plan for repaying the loan. “Our approach to premium finance is that we look for a source of repayment other than the death of the insured,” says Taylor Miller, Private Banking Managing Director for The Private Client Reserve in Kansas City. “That source could be the sale of a business or real estate that will provide liquidity, for example.” In general, the debt would be retired before the life insurance policy is redeemed.

 

Premium-financing transactions are complex, and they are best suited to those who are willing to spend time managing the loan. “It really needs to start with a client working with a group of tax, legal and financial advisors to understand their current financial situation and their holistic views on money and their legacy,” Miller says. “From there, they come up with the best plan they can, and if their estate appears to be subject to a tax liability, then the discussion of how to pay for that estate tax can take place.” 

 

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