Our industry has been buzzing about the opportunities created by the reunification of the estate and gift tax along with the increased lifetime exemption of $5 million all year.  One of the aspects we have not yet touched on here is the enhanced ability to integrate a gifting strategy with premium financing.   

First, let's dispel a myth - premium finance is alive and well.  For the truly high net worth client who has the ability to pay the premiums but would rather keep their capital deployed it is truly worth considering.  The days of easy money for those who are "cash poor" and could not really afford the premiums, however, are long gone.  Given that, how about we all agree that any client who is in the position to make a sizable lifetime gift in the next nineteen months is going to fall into the first group?  Great, now how would a financed solution work here?

First, we need to remember that the assets gifted into an ILIT as part of this strategy are now "separate capital" and should be treated as such.  The result is that there is a completely different set of objectives and corresponding risk tolerance for this portion of their portfolio.  We have already investigated the impact of life insurance in that portfolio (click here if you missed it the first time), but today we are taking on how to pay for it.

Rather than liquidating a portion of the portfolio to single pay the insurance, or even doing so on an annual basis, a financed solution allows the client to stay fully invested, less a rather modest interest payment each year.  The issue of collateral is not nearly the hurdle it was as the ILIT has more than enough assets to cover the collateral requirement.  In fact, having the trust funded with a significant amount of capital allows us to create a "closed system", meaning that all of the moving parts required to make a financed structure work are contained within the trust itself (collateral, side fund, policy, etc.).  As a result, the day to day economic impact on the client is rather negligible, as they have already gifted these assets away.

This idea of a closed system also provides the exit strategy that is so vital to a well-designed finance structure.  Every financed policy has the potential to reach a "crossover" point, where the interest service becomes onerous or exceeds what the client would have paid out of pocket to fund the policy.  When that happens, it is time to consider paying off the loan.  The source of funds is usually the policy, but one of the risks in these situations is the impact on the long term health of the policy if a sizable withdrawal is made to pay off the loan.  In this case, there is already a side fund created by the initial gift and savings each year (interest payments versus premium payments) sitting in the trust!

One note of caution - I have found that when the lead in to the sale is "finance the premiums" the probability of the sale actually closing drops dramatically.  I think the decision for the client is framed as "buy insurance via premium finance or don't buy" versus "buy insurance and determine the most effective way to pay for it".  Clearly the latter identifies the true insurance buyer, while the former may just be after a free lunch.  When it turns out to not really be free, that prospect tends to walk away.

Regardless of how you frame the sale, the moral of the story is that anyone who is a candidate for large gifts based on current estate tax laws needs to make intelligent decisions about how to manage the assets they gift away.  Perhaps more than ever, premium finance is a very attractive way to maximize the amount ultimately passed to the next generation.

Have a great weekend.