The threat of tax increases and a reduction to the federal estate tax exemption is something high-net-worth families must always take into consideration when planning for wealth preservation. One strategy investors and family offices are increasingly relying on to prepare for an eventual shift in tax policy is private placement life insurance (PPLI).
The traditional goal of life insurance, including term and permanent types of coverage, is to pay the lowest possible premium for the maximum amount of death benefit, or maximum return on death benefit. Whereas term policies provide needed coverage for a specific period of time, permanent coverage typically is designed for an individual’s lifetime.
There are various types of permanent coverage, including whole life, universal life, variable life and index universal life. The key differences between them come down to how the mortality costs are calculated and the earnings potential of the cash value. For those people seeking maximum return on cash value, policies are deigned with the lowest possible death benefit and, therefore, the lowest possible mortality costs and greatest amount of premium applied to the cash value. For greater investment potential, individuals may consider variable or index policies, in which the cash value can be invested in equity-oriented strategies that have the potential for stock-market-like returns over time. As a result of this investment flexibility, low cost and significant tax benefit, many high-net-worth families have turned to Private Placement Life Insurance (PPLI).
With PPLI, policyowners receive the favorable tax benefits of a life-insurance contract wrapped around a broader range of investment options than one would typically find in a traditional cash-value life insurance policy. This can include investments reserved for institutional investors and those that have high turnover and are tax inefficient, including private equity, venture capital, hedge funds, real estate and other alternatives. Because these assets are held within the insurance wrapper, appreciation from market gains, interest and dividends escape both income and capital gains taxes and can be accessed by policyholders free of income tax. Moreover, distributions from PPLI policies are taxed on a first in, first out (FIFO) basis, meaning that policyholders can withdraw any amount they put into the policy free of tax and borrow against any appreciated value without incurring tax liabilities, as long as the policy remains in force. In other words, the PPLI wrapper helps to make tax-inefficient investments tax-efficient, and allows policyholders to minimize the risks of rising ordinary income and capital gain tax rates, that can be as high as 50 percent, depending on where the policyholder lives.
Unlike a standard life insurance policy that is funded primarily to provide a tax-effective death benefit to heirs, PPLI is a tax-efficient investment- and income-planning strategy. Therefore, the life insurance costs of these policies are kept at a minimum. Over time, as the cash value in the policy increases, internal mortality costs and other expenses can be paid by the policy itself rather than out of insureds’ pockets. At the same time, insureds can access those accumulated funds tax-free during their lifetimes, up to certain limits. They also have the option to use the policy as collateral to obtain a loan for short-term liquidity needs without requiring them to sell other highly appreciated assets and potentially wreak havoc on other estate-planning strategies.
In return for all the flexibility and tax benefits of holding investment in PPLI, policyholders must abide by strict IRS standards, including medical insurability and investment diversification. While policy owners may choose to allocate their investments from a long menu of options, including mutual funds, ETFs and index funds, they are generally prohibited from directing the day-to-day decisions of the fund managers. PPLI is a complex vehicle that must be structured very carefully under the guidelines of experienced advisors to avoid sidestepping IRS regulations.
About the Author: Eric P. Zeitlin is CEO and managing director of Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors + CPAs, and a registered representative with Raymond James Financial Services. For more information, call (954) 712-8888 or email info@provwealth.com.
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Eric P. Zeitlin is a registered representative of and offers securities through Raymond James Financial Services, Inc., Member FINRA/SIPC.
Raymond James is not affiliated with and does not endorse the opinions or services of Berkowitz Pollack Brant Advisors + CPAs. PWA is not a registered broker/dealer and is independent of Raymond James Financial Services. Investment Advisory Services offered through Raymond James Financial Services Advisors, Inc., and Provenance Wealth Advisors.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of the advisors of PWA and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Investments mentioned may not be suitable for all investors. You should discuss any tax or legal matters with the appropriate professional. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
Private Placement Life Insurance policies are unregistered securities products and are not subject to the same regulatory requirements as registered securities products. As such, Private Placement products should only be presented to accredited investors or qualified purchasers as described by the Securities Act of 1933. The information presented here is not an offer to purchase or the solicitation of an offer to purchase an investment product.
Variable life insurance is long-term investment and may not be suitable for all investors. Investments in variable products are subject to fluctuating values of the underlying investment options and entail risk, including the possible loss of principal. Product guarantees, including the death benefit, are subject to the claims-paying ability of the issuing insurance company.
Alternative investments are available only to those who meet specific suitability requirements, including minimum net worth tests. Please review any offering materials carefully and consult with your tax advisor or accountant prior to investing. There are special risks involved with alternative investments, including investment strategies, and different regulatory and reporting requirements. There is no assurance that any investment will meet its investment objectives or that substantial losses will be avoided. Alternative Investments involve substantial risks that may be greater than those associated with traditional investments and may be offered only to clients who meet specific suitability requirements, including minimum net worth tests. These risks include, but are not limited to, limited or no liquidity, tax considerations, incentive fee structures, speculative investment strategies, and different regulatory and reporting requirements.
Changes in tax laws or regulations may occur at any time and could substantially impact your situation. You should discuss any tax or legal matters with the appropriate professional.
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Posted on November 24, 2022