By Greg Hutto, CFP®, CFA®
“How much life insurance would you want, Mr. or Mrs. Corporate Executive, if you didn’t have to write a check for it?” Most people would say, “As much as I can get!”
Well, Mr. or Mrs. Corporate Executive, you won’t qualify for unlimited life insurance. But you can likely qualify for more than you expect through safer versions of premium financing.
You Need Life Insurance Whether You Die Young Or Old
And just in case you’re wondering, Mr. or Mrs. Corporate Executive, here’s why you need to get serious about life insurance. If you die young, your heirs and dependents will need a way to replace your income. Or, in the better scenario, in which you live a happy, fulfilling life for a good long while, your heirs will need some help paying your estate taxes (especially if you live past December of 2025 , the date that the estate tax exemption is scheduled to be reduced).
So, you need life insurance. But what’s the most effective way to get the amount you need? In other words, why write a check for life insurance premiums if you can avoid it? (Safe avoidance, of course. We never want you to take on any undue risk.)
As a high-net-worth individual (HNWI), you need a lot of life insurance. Average Joe might get away with a $1 million or $2 million policy. But you, my friend, need a lot more than that. Of course, the amount of life insurance you need means you’ll be paying pretty outrageous premiums—potentially ranging from $2,000 to $15,000 a month. You read that right. $15,000. A month.
The Risks of Premium Finance Structures
Knowing that you probably want to keep that kind of cash in high-return investments, traditional premium-finance structures could make sense for your situation. As a quick reminder, premium financing basically means taking out a third-party loan to satisfy the premium amounts, with the idea that the interest you pay on the loan is lower than the interest you earn on that invested cash.
But before you get too excited, there are risks associated with premium financing you should be aware of.
1. Spread Risk
The first type of risk is called spread risk. Spread risk means that the cost of funds (the interest on the loan) is more than the interest credited inside the policy when the funds must be paid back.
An index universal life (IUL) policy is likely the best type of policy for premium-finance. There’s less risk when taking out an IUL policy than on a variable universal life (VUL) contract. However, even an IUL policy can go upside down, which is when the interest credited in the policy is less than the interest owed on the loan. This “upside-downing” results in actions that must be taken to get rightside up—and none of these actions are in your best interest.
2. The “Personal Guarantee”
The second risk of premium financing is that you may have to provide a personal guarantee on the arrangement. Traditional premium-finance arrangements contain language that obligates the insured to sign a personal guarantee, which states that you will back the loan with personal funds if the policy should go upside down.
This condition is obviously disadvantageous to the investor. The whole point of doing a premium-finance arrangement is to avoid having to use personal funds. Luckily, there are structures in place now that don’t require the use of a personal guarantee. Instead, an investor can post a small amount of collateral, which has a very low probability of ever needing to be used.
So Should You Do It?
Does premium-financed life insurance make sense for your situation? Perhaps, but better (safer) versions exist today, which do not require the use of a personal guarantee, and reduce spread risk to be a very unlikely occurrence. You can now borrow funds with safer structures in the mid 2% range, which mitigates spread risk significantly.
Either way, as an HNWI, you should be exploring all options. Your personal finance situation is just that—personal. So you shouldn’t have to settle for paying premiums out the wazoo just to protect your estate and your family.
Let Us Help
Your best strategy is always to consult a finance professional. At Heritage Retirement Advisors, we’re ready to talk with you about options that are less risky when it comes to premium financing and help you make the most of your investable assets. Give us a call at 817.503.0100 or email email@example.com to schedule a free introductory meeting.
Greg Hutto, president and CEO of Heritage Retirement Advisors, comes from a family of educators, so it’s no wonder he holds a bachelor’s degree in business from Texas A&M University, and a master’s degree in education from Tarleton State University. He spent years as a teacher and coach before entering financial services in 1996. After 14 years in the industry working for such powerhouses as UBS Paine Webber and Raymond James, Greg founded Hutto Retirement Advisors LLC in 2010, now Heritage Retirement Advisors. He holds both the Certified Financial Planner® (CFP®) and Chartered Financial Analyst (CFA®) designations. Additionally, he is the founder of Heritage Tax Advisors LLC. Greg and his wife, Angie, have three children. He likes to cycle, play golf, travel with his family, and he’s still trying to convince Angie of his dream of being husband-and-wife truck drivers, or at least working and living on the road in an RV! To learn more about Greg, connect with him on LinkedIn.