Premium financed life insurance is a strategy which is becoming more common today among financial advisors. Some advisors consider premium financing a risky strategy while others are confident in the policy’s ability to perform as expected. Before investing in any Premium Financed Life Insurance, one must learn what exactly it is and how much risk should be taken.
Borrowing funds from a bank in order to finance a life insurance policy is called Premium financing. Premium financing is often pitched with the idea that the policy holder can get life insurance essentially for free. When a loan is taken to pay the premium, there is no out of pocket expense for the policy holder. The policy is expected to perform well enough to pay back the principal and interest on the loan, leaving the life insurance policy for the holder.
Premium financing can work if designed and monitored properly. However, both the advisor and the client should be aware of the “risks” of premium financing that can cause the policy to fail in order to better negate the potential hazards of premium financing. Below are some points to keep in mind before investing in any Premium Financed Life Insurance Policy.
- Most of the Premium Financed Life Insurance policies come with fairly high fees. The commissions are often front-loaded. The costs can eat up your returns, so it can take years before your cash fund sees significant growth. Later in life, your premiums might go up, and leave you without enough in your cash fund to keep the policy in force.
- Taxation can be tricky to prepare for in a premium financed policy because the extent to which taxation occurs depends on the success of the policy. Before creating the policy, it is important to consider all of the necessary tax implications to ensure the ending value of the death benefit of the policy at maturity exceeds the loan amount.
- There is no guarantee the lender will renew the loan if needed. If the lender does not renew the loan, the client must give what was promised as collateral to pay off the loan and the policy lapses leaving the policy holder with no policy.
- The longer the loan lives, the more expensive the loan becomes. Lenders are often free to increase loan rates and spreads as they see fit.
- Unlike typical cash value insurance policies, premium financed life insurance is an illiquid asset as the owner cannot borrow or withdraw money from the policy because the contract acts as collateral for the loan.
Premium financed life insurance services is a powerful solution under the right circumstances. However, here are times it is oversold with severe personal and financial consequences. Getting a second opinion is regularly a good way to ensure you are not getting ripped off.