Financial Advisors

Private Placement Life Insurance Primer

It seems like every day there is a new big idea for shielding your wealth and income from the IRS. This new idea centers around an investment that most would not consider trendy: Life Insurance.

Basic Life Insurance, or Term, offers a death benefit that diminishes over the years, permanent products which offer a guaranteed death benefit and builds up cash value over time and whole life that will accumulate cash value from the premiums that are paid into the policy.

Greater cash value can be achieved with a Universal Life policy, which are usually linked to one or more investment accounts. Some of these investment accounts can be very conservative, with growth based on a specific market index or an account paying a low fixed interest rate and some of the variable rate policies results are based on market based investments, usually involving greater risk.

For the affluent investor, it is not about how much their investments earn but how much they walk away with. Taxes can turn the greatest of investments into something mediocre and this is sometime the case when it comes to hedge funds. Some hedge funds may produce above average returns but their strategy may not be the most tax-efficient, resulting in less of a return for their investors. There are many ways for an investor to mitigate the tax burden from their investment. In the case of a hedge fund, a highly effective way is from the use of Private Placement Life Insurance (PPLI).

PPLI is a solution that was designed for wealthy individuals, in a high tax bracket, who have a few million dollars to commit to the venture. It is a variable universal life policy whose cash value increases are based on a segregated investment account and a life insurance policy. If structured properly, it should be able to provide the purchaser with:

  • Tax-Advantaged Income
  • Tax-Free Growth with-in the policy
  • Access to Tax-Advantaged cash
  • Creditor Protection, in some states
  • A Tax-Free death benefits

The idea behind a PPLI is to combine the financial advantages of highly taxed hedge fund and other similar investments with the tax advantages of Life Insurance. There will be costs associated with the Life Insurance policy but the tax savings, in a properly structured contract, plus the death benefit more than make up for the costs.

Private Placement Life Insurance can be a very powerful solution for the right client and typically they have to have:

  • A high Net Worth
  • The ability to fund $2.0m or more in premiums for several years
  • The desire to invest in Hedge Funds or alternative investments
  • Tax-Efficient Investments
  • To reside in a highly taxed area (state & local taxes)
  • The desire to shelter assets from creditors

Everyone has the ability to purchase a variable universal Life Insurance policy but the way a PPLI is structured they are an unregistered securities product. That being said, an agent can only present them to an Accredited Investor, defined by the SEC as:

  • A person with a net worth of at least $1.0m, excluding a primary residence, or at least $200k of annual income in the preceding 2 years.
  • A married couple with income of $300k in the preceding 2 years.

The owner of the policy is usually an individual or a trust. But if the policy is held in an irrevocable trust, it can be kept out of their taxable estate, possibly reducing the Estate’s tax liability. Another advantage is the owner can have their Personal Money Manager manage the policy.

What makes a PPLI unique is not any special tax loopholes but the multitudes of investment options that are available to the accredited investor, qualified clients and purchasers who are approved to purchase this product. They can either have their own advisor manage the portfolios within the policy or choose a selection of funds that are managed by top money managers. Possible investments can include venture capital, private equity funds, Hedge or Commodity funds or any fund that will generate short-term capital gains. And they still must meet IRS standards for Investor Control, Insurance and Diversification.

  • Investor Control: Individual owners or family offices cannot exercise any influence over the specific decisions of the Fund Managers. Too much influence may result in the IRS disqualifying the tax advantages of the policy. Managers must operate on an independent basis. Any asset on the PPLI is not designed to be separately managed and nor should they be.
  • Insurance Standards: Insurance Dedicated Funds (IDF) reside within the policy and the owner may sell them as often as they want and replace them with other qualified investments. They are specifically designed for the PPLI market.
  • Diversification: All investments must meet diversification rules:
    • No singe investment can make up 55% of the portfolio
    • No two investments can make up 70% of the portfolio
    • No three investments can make up 80% of the portfolio
    • No four investments can make up 90% of the total assets of the account.

The investment portfolio must contain a minimum of five distinct investments to qualify as life insurance. If it doesn’t maintain the minimum, the IRS will disqualify the policy and the owner will lose the tax advantages it achieved.

The policy owners can withdraw or borrow from their cash value at any time for any purpose:

  • Withdrawals: They are usually tax-free, up to the basis of the policy. This means the owner can get back their premiums, minus fees, without any tax consequences, as long as the accounts performance has maintained the cost of insurance. If the cash value is greater than what was paid in, any additional withdrawal over the basis will be taxes as a gain.
  • Policy Loans: Loans can be taken at any time, with no underwriting or background checks. Any loan is secured by the policy’s cash value. Loans do not have to be paid back and interest rates are usually very low. Borrowers need to be aware that interest does accrue and the death benefit is reduced unless the loan is paid back.

Private Placement is income tax efficient while providing the owner with tax-free access to the policy’s cash value. It is a very powerful solution for the right wealthy client in the right circumstances. It has many advantages but there are also limitations. Only by working with a qualified financial or legal professional can it be determined that it is right for you.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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David Kleinhandler

David Kleinhandler is the Founder and President at Vest Financial Group, as well as Founder and CEO at Blackridge Capital Group. As a 25-year entrepreneur and investor, David Kleinhandler founded Blackridge Capital in 2014 to create an investment vehicle for private investments and the creation of new companies in the financial world. David’s latest endeavor, Vest Financial, strives to make financial wellness simple, as an employee benefit or as an advisor tool.

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