No one enjoys paying capital gains taxes (well, maybe other than the IRS). That is why figuring out how to lawfully take advantage of tax shelters to decrease your tax burden may be a valuable tool in protecting and increasing wealth. It’s also why private placement life insurance (PPLI) is becoming more popular among the wealthiest 10% of Americans looking for tax shelters other than typical annuities, IRAs, or other retirement accounts.
Accredited investors can buy a private placement life insurance policy to get a tax break on their investments in real estate, enterprises, securities, and other assets. It does, however, come with certain drawbacks. Continue reading to see if this investment instrument is a good fit for your cash.
What is a Private Placement Life Insurance Policy?
PPLI is a type of life insurance that is designed to have a high cash value in comparison to a low death payout. To reduce fee drag, the life insurance component is maintained as low as feasible, allowing the policy’s cash value to ultimately drive the death benefit.
The purpose of PPLI is to swiftly accumulate large cash value within a life insurance policy in order to benefit from the tax-free treatment of income and gains from the policy’s underlying assets. While PPLI is founded on a life insurance foundation, it is primarily an income tax technique for investing, not an estate preparation approach.
It is essentially a variable life insurance policy that allows you to allocate to different investments that are not available in more standard variable universal life plans.
How Does Private Placement Life Insurance Work?
Privately placed life insurance is typically designed as a variable universal life insurance policy, which means:
- Premiums are adaptable. Policyholders are free to pay as much or as little premium as they want, whenever they choose.
- Each month or year, the cost of insurance is withdrawn from the cash value in the policy subaccounts.
- To keep the policy active, the owner must pay enough premium to keep the cash value high enough to cover the cost of insurance.
- The policy will lapse if the cash value reaches zero.
The policy is typically structured by the agent who puts it up to optimize cash value accumulation while keeping the death benefit (and consequently the cost of insurance) reasonably modest. Working with their insurance expert, the policy owner then pays as much premium into the policy as possible each year.
The client benefits from the life insurance contract’s significant tax advantages:
- Heirs receive tax-free death benefits.
- Cash value growth that is tax-deferred
- Dividend growth that is tax-free (if applicable)
In the meantime, the insured retains access to accumulating cash values, which can be used for any purpose and accessible at any age. There are no penalties for withdrawing the cash value prior to reaching the age of 59 1/2, as there are with annuities and individual retirement accounts (IRAs). Furthermore, unlike annuities, IRAs, and retirement funds, there are no mandatory minimum distributions.
Where Can I Get a Private Placement Life Insurance?
Because the primary purpose of PPLI is not to reduce estate taxes, many investors will own these policies directly within their taxable estate. Owning PPLI in an Irrevocable Trust is certainly viable and preferred if sufficient assets are available that are not subject to federal and state estate taxes.
For customers who want to leave a major percentage of their assets to a private foundation upon death but aren’t ready to give up personal access to those assets, investing through PPLI or PPVA can expedite the process of effectively making those assets income tax-free. The private placement life insurance or PPVA policy would be owned directly and would be included in the taxable estate. The death benefit is given out in cash upon death. The value of the death benefit paid to charity, which has grown tax-free, will also transfer estate tax-free.
Another is in collaboration with a Grantor Charitable Lead Trust (CLT). When you fund a CLT, you can claim an immediate tax benefit in exchange for reporting the CLT’s income in future years on your personal tax return. A PPLI or PPVA policy can reduce the flow-through income back to you, allowing you to take advantage of the upfront deduction while avoiding the ongoing phantom income.
Why You Should Not Consider a Private Placement Life Insurance Policy?
One of the major conditions for meeting IRS PPLI rules is that the policyholder relinquishes investment authority over the underlying assets.
There are numerous investment choices available in the form of commingled funds on each carrier’s platform from which a policyholder can select. Furthermore, certain insurance companies provide managed accounts. In these cases, you can select from a variety of methods and investing objectives, but not individual assets.
If the IRS determines that you, the investor, have too much control, the PPLI will be treated as if it never existed at all, and any income tax benefits will be lost.
A hands-on investor who is hesitant to take over control of a portion of their investment portfolio may struggle to accept this technique.
Private Placement Life Insurance Investments
As previously stated, tax-inefficient investments are the ideal candidates for a private placement life insurance policy. They generate significant current taxable income, imputed (phantom) income, or capital gains unless they are held in a tax-free retirement account or life insurance vehicle.
Owners of PPLI policies and their advisers can either select particular investments for their portfolios or carefully select money managers to manage their portfolios under the policies. Venture capital, real estate investment trusts, private equity funds, funds of hedge funds, commodity funds, and any other fund with exceptionally high turnover rates that create significant short-term financial gains are all possible investments.
But that doesn’t imply anything is off-limits. PPLIs must continue to meet IRS requirements for investor control, insurance, and diversification.
#1. Investor control
Individual policyholders and family offices are not permitted to exert influence over the fund managers’ specific investment selections. If the owner exerts too much control, the IRS may reject the policy’s tax benefits. Current case law requires managers to act independently and discretionarily. Assets maintained in PPLI policies are not intended to be independently managed accounts and should not be viewed as such.
#2. Insurance requirements.
The life insurance structure allows policyholders to sell insurance-specific funds inside the policy as often as they like and replace them with other suitable investments without incurring tax penalties. IDFs are financial instruments that are specifically intended for the PPLI industry. Hedge funds and funds of funds frequently construct an IDF version of their flagship offering that employs all of the same techniques and managers but is also managed to comply with the laws and regulations that regulate insurance portfolios.
#3. Diversification is required.
Diversification principles must also be followed when making investments:
- A single investment shouldn’t account for more than 55% of the insurance subaccount portfolio.
- No two assets may account for more than 70% of the portfolio.
- No three investments may account for more than 80% of the portfolio.
- Also, four investments may account for more than 90% of the account’s total assets.
As a result, in practice, the portfolio must comprise a least five unique investments in order to completely qualify as life insurance. Otherwise, the policy will be disqualified by the IRS, and the owner will lose the tax benefits of the life insurance arrangement.
Getting Access to your Money in a Private Placement Life Insurance
Policyholders can withdraw or borrow against their cash value at any time and for any policy.
- Withdrawals are tax-free up to the policy’s maximum. So owners can recoup their premiums, minus costs, without incurring tax implications – as long as the performance of their subaccounts has kept pace with the cost of insurance. If the cash value exceeds the owner’s basis in the policy — that is, what they paid in — then any additional withdrawals in excess of the basis are taxed as a gain.
- You can borrow against the policy’s cash value with no underwriting or credit check. The cash value of the policy serves as collateral for the loan. As a result, the policy is a good alternative for emergency money. The loan is not required to be repaid, but the policy owner may wish to refill funds borrowed from the policy in order to maximize long-term tax-free growth.
- Interest rates are frequently quite low because the loans are backed by payments already made to the insurer. Borrowers should be advised that interest does accrue and that borrowing reduces any death benefits given out unless the loan is repaid to the policy.
What distinguishes private placement life insurance policies from retail life insurance policies?
Privately placed life insurance is structurally equivalent to a traditional variable universal life insurance policy. The assets maintained in the subaccount are what distinguishes the PPLI: A typical retail consumer will select from the life insurance company’s limited menu of subaccount investments.
When you purchase a PPLI, however, you can tailor your investment subaccounts. You can incorporate almost any type of investment, from index funds to hedge funds. Your registered investment advisor or wealth manager can assist you in developing the investments in your subaccount menu.
PPLI’s tax advantages and other advantages
Individuals with high incomes are extremely tax-conscious. In 2018, the ordinary income tax rate on earnings over $518,401 was 37%, plus additional Affordable Care Act taxes on high-income persons. When state and local income taxes are considered in some areas, the income tax impact for high-earning households can reach nearly 50%.
This technique mitigates the impact of current income by putting assets in a life insurance policy with tax benefits similar to a Roth IRA. Assets held within the policy grow tax-free for the duration of the policy.
PPLI plans frequently give a variety of additional benefits in addition to the tax advantages that normally apply to life insurance cash values:
#1. Commissions are reduced.
In comparison to most retail life insurance plans, the cost of insurance and commissions is low: Issuers care more about managing your money than they do about making big upfront commissions.
#2. There are no surrender charges.
They do not need to impose surrender charges to collect commission costs because they do not rely on a commission-paid insurance sales team as traditional insurance companies do.
#3. Phantom income is exempt from taxation.
Even if no cash income is distributed, some assets incur a tax liability for the owner. A zero-coupon bond, for example, pays no income until it matures, but the IRS requires taxpayers to pay taxes on imputed income as the bond approaches maturity. The tax on imputed or phantom income is offset if the asset is held in a PPLI.
#4. Tax compliance has become less difficult.
Tax reporting is a perennial source of frustration for hedge fund investors as well as those with interests in limited partnerships and master limited partnerships. The taxpayer can avoid dealing with K-1 filings and other reporting obligations by storing these assets in a PPLI.
Cash-value life insurance is a tried-and-true strategy to protect assets from creditors. In every state, life insurance and annuities provide substantial asset protection, and in certain states, such as Florida and Texas, creditor protection is infinite. In other situations, PPLI life insurance assets are held offshore, making them inaccessible to U.S. courts. No US court has the authority to compel a foreign corporation to release funds to a creditor.
This type of investing does come with considerable costs and premium obligations, but for people who have a high tax burden, the tax benefits frequently surpass the fees. Speak with your tax professional as well as numerous insurance brokers to acquire a thorough grasp of the various offers and how they might help you with your entire tax plan. While it is not a suitable fit for the bulk of the people, it does satisfy a critical need for many authorized investors.
What is private placement variable universal life?
Private Placement Variable Universal Life Insurance (PPVUL) is a customizable life insurance product that is only available to a limited number of “qualified purchasers” who meet certain net income and net worth standards.
Do billionaires buy life insurance?
Wealthy people get Life Insurance to ensure that their wealth is passed on to their heirs when they die. Income replacement is a worry for people of all income levels, although it works on a different scale for the wealthy. Second, wealthy people purchase life insurance to help pay future estate taxes.
Do millionaires need life insurance?
Life insurance is a common tool for the wealthy to increase their after-tax inheritance and leave more money to heirs. A life insurance policy can be utilized as an investment instrument or to give additional financial security.