Husband and Wife are each 60-years old and in excellent health. They have a substantial net worth acquired as real estate developers.
Clients’ attorney has recommended $10 million of survivorship coverage for estate planning purposes with a $200,000 annual premium payable for lifetime owned by and payable to an irrevocable life insurance trust (ILIT). Client is heavily invested in real estate, and likes the concept of using other people’s money to fund the coverage. The Client expects to sell substantial properties in the next 3-5 years, freeing up funds to repay the loan and pay future premiums.
- The Client or Clients create an ILIT.
- The ILIT enters into a premium financing arrangement with a third party commercial lender.
- The ILIT will borrow each annual premium for up to seven years, pay the policy loan interest, posting the policy cash value and a portion of the death benefit as collateral.
- To the extent that the policy cash value is insufficient to secure the loan, the Client posts collateral in the form of cash, marketable securities or a letter-of-credit acceptable to the lender.
- Assuming the current loan rate is 4% (and will remain at that rate), loan interest on a $200,000 annual premium equals $8,000. The Client gifts $8,000 to the ILIT. Note: Borrowing rates typically vary at least annually.
The level 4% rate is assumed for the sake of simplicity.
- In the second year, an additional premium is borrowed for a total loan of $400,000, and the loan interest is 16,000. After 5-years, the total loan would equal $1,000,000 with an annual interest payment of $40,000.
- At the same time that the ILIT purchases the policy, the Client gifts an interest in the discounted real estate that the clients’ expects to sell in the next 3-5 years. This acts as an exit strategy by providing a source of funds in the ILIT to repay the loan in the future and generate cash flow to pay future premiums.
- Upon death, the policy proceeds are paid to the ILIT, net of the outstanding loan balance. Net proceeds or assets purchased from the estate with such proceeds are then managed and distributed according to the terms of the ILIT.