Should You Consider Taking a Loan to Finance Life Insurance?
January 7, 2015 | Your Finances
Bank financing can be a great option when you’re purchasing a home or a car. But does it ever make sense to take out a loan to pay your life insurance premiums?
There are situations when it may make sense. But bank-financed life insurance isn’t for everyone.
“It seems like a simple and straightforward proposition,” said Beth Taylor, director—estate market for life and annuity products at Northwestern Mutual. But there can be a significant variety of outcomes and risk levels, depending on how you proceed.
Deciding If It’s Right for You
Borrowing to finance life insurance premiums works best in cases where a large death benefit is required. The person buying the policy must have a high enough net worth to justify such a large death benefit, but he or she may not want to access money to pay the policy’s premiums.
“There is no one magic number,” said Taylor.
When Does Financing Work?
“Suppose you own a thriving business that’s been growing at a 10 percent annual rate or better,” Taylor said. “If you expect that growth rate to continue, you’d probably want to reinvest all of your earnings right back into the business,” Taylor said. In that case, she added, borrowing the premium at a lower interest rate might make good business sense.
Another instance where financing could work is for an individual with extensive but illiquid assets. Taylor recalls one client who owned $30 million in real estate assets but did not plan to sell any of those assets for at least three to five years. Borrowing during the interim to pay the insurance premium could be warranted. In that case, the decision worked over the short term, when the interest rate and the value of the properties both remained stable.
Plan an Exit Strategy
Begin with the end in mind. Before moving ahead with a financing plan, Taylor says it’s important to have an exit strategy ready. “Going in, you should know how you will make your payments,” Taylor said. If your plan includes using the value of your policy to make payments, financing probably isn’t the right option for you.
In addition, you should plan an exit strategy you can use if changing circumstances require it. What if interest rates rise unexpectedly? Or the bank opts not to renew the loan? Or the assets serving as loan collateral fail to hold their anticipated value? An effective exit strategy as part of an overall plan will help you prepare and plan for such challenges.
“If some unexpected crisis develops, some people may be tempted to resort to a quick fix,” said Taylor. “Our expectation for our clients is that the loan must be repaid with assets outside the policy,” Taylor said.
Have a Larger Plan
It’s important to make your decisions part of a larger financial plan. Review that plan with your financial professional regularly—every six months to a year—to make adjustments as your needs change.
In addition, Taylor says it’s a good idea to work with a team of advisors when considering financing for life insurance. Your team should include advisors like an attorney or an accountant and include someone who does not have a financial stake in the deal.
With the right resources and advisors behind you, bank-financed life insurance can prove an important and useful tool for people who have a high net worth and a situation that warrants the arrangement.