Spotlight On
Private Placement Life Insurance
By Jerry W. Hester, II CLU® - Founder/Principal of Hester Insurance Group LLC
Affluent individuals and families often invest in attractive but highly tax-inefficient investments. An asset with a great return can turn sour once taxation is accounted for. An increasingly popular solution with savvy investors is Private Placement Life Insurance (“PPLI”). These investments, if intended to be held for ten or more years or potentially for life, could benefit within a life insurance structure that could produce incredible tax savings and bolster wealth transfer.
Private placement life insurance offers investors tax-deferred growth, tax-free access to capital and the ability to pass investment income tax-free at death.
More than Life Insurance
On the surface, having a stated death benefit, flexible premium payment schedule, and a cash value savings component makes private placement life insurance (“PPLI”) similar to a typical variable universal life contract. However, there are differences that have benefits. A PPLI policy is an unregistered securities product, not subject to the same regulatory requirements as registered variable products and only available to clients who are accredited investors and/or qualified purchasers.
Retail variable life insurance contracts are generally purchased by someone concerned with the death benefit protection the policy provides. Purchasers of PPLI are most interested in the ability to customized investments within the policy and to see the value of those investments grow tax deferred. In other
words, the choice of a PPLI policy is generally made for investment purposes, and not for life insurance needs. The client only needs to purchase the minimum amount of life insurance the IRS requires for the policy to be deemed life insurance and not an investment. This permits the benefits of life insurance, such as tax-free cash value growth, tax-free policy loans and a tax-free death benefit, to be recognized.
The Crossover Point
PPLI contracts are unique in the life insurance landscape due to its institutional pricing, flexibility in design and NO surrender charges. This “uniqueness” allows potential buyers to evaluate if the higher insurance costs in the early years of the policy are outweighed by the tax savings. This is commonly known as the ‘crossover point.’
A crossover point occurs (typically after seven to ten years) when the IRS permits a substantial drop-off in the minimum amount of required death benefit after a number of tests are met around what constitutes the definition of life insurance. At this point, the tax-free growth of the investments underlying the policy can accelerate. This means a client considering PPLI should have a long-term investment horizon to be able to reach this crossover point, after which, the policy performs best.
Benefits of
Private Placement
Life Insurance
-
Investments Grow Tax-Deferred
-
Investment Strategy Free of U.S. Tax Considerations
-
Tax-free Access to Capital via Policy Loans
-
Ability to Transfer Investments Income Tax-Free at Death
-
Access to Alternative Assets
A Wealth Transfer Tool
While a PPLI policy’s death benefit is incidental to the investment purpose of the contract, the death benefit can play a useful role in wealth transfer. Investments held personally at death are included in client’s estate and are generally subject to probate. Conversely, as a part of a PPLI policy owned by an irrevocable trust, investments-in-kind or in cash-can be passed estate tax-free and income-tax free at the death of the insured client as the policy’s death benefit, creating a step-up in basis. The policy death benefit proceeds would be greater in value than the investments and would also circumvent probate and be directed to listed policy beneficiaries.
Permissible Investments Under PPLI
What type of investments can be held within a PPLI policy? This is where some of the restriction and rules the U.S. Treasury has developed come into play in order for a client to maintain the benefits of PPLI. A client may choose from one or more Insurance Dedicated Funds (“IDFs”) to serve as the cash value component of the policy, a Separately Managed Account (“SMA”) or a combination of the two. There are also investor control prohibitions and investment diversification thresholds as described in IRC §817(h) which call for a minimum of five different investments, with no one investment making up more than 55% of the total value, no two investments making up 70%, no three investments making up 80% and no four investments making up 90% of total value.
An IDF is simply an ‘insurance policy appropriate’ version of a fund a client may purchase directly. Many IDFs are hedge, direct lending or credit funds or other tax-inefficient funds which would greatly benefit from the tax-deferral a policy provides. The ‘appropriateness’ derives from the IDF treatment as a separate legal entity which cuts off investor control from the client and meets the required diversification of investment positions with the fund. Therefore, a client can personally choose just one IDF to be included and comply with the investor control and diversification tests.
A SMA can be identical to a SMA held outside of policy where a basket of investments is held. In a policy, direct investments into funds can be made within the SMA without the need of an IDF structure. However, there must be an independent manager making decisions about what is included in the SMA and the number and value of the investments in the SMA should be properly diversified. The types of investments which can be include in a SMA are broad and can include funds, LP interest in LLCs, LP interest in private equity and, even third-party promissory notes.
Clients are finding SMAs more and more useful when purchasing PPLI. The ability for their investment advisor to recreate an existing investment methodology with a policy is enticing, especially where a client would be invested for the time horizon making PPLI beneficial.
Case Study
Grace, age 50 and a resident of Chicago, is an accredited investor who invests $5 million a year into a SMA managed by an independent investment advisor. She knows she will invest for at least five years and likely not touch the money for twenty years, if at all. The SMA contains a mix of investments with an exposure to short- and long-term gains and taxation at ordinary rates.
Her investment manager projects a 7% return and Grace’s average tax rate is 25%. Using these assumptions, after 20 years, her portfolio would be worth approximately $61 million.
Grace instead chooses to invest into the SMA under a PPLI policy. While the investments grow tax-free, policy costs average 1.1% a year. After twenty years, the policy value will be approximately $71 million --$10 million more than if Grace had not chosen PPLI. Further, Grace is able to access the money as tax-free policy loans and, should she pass away, a sizeable, income tax-free death benefit will be paid to her beneficiaries.
The Right Choice?
For affluent investors who face penalizing taxation with their investment choices or who need an efficient method of wealth transfer, PPLI can be an incredibly powerful tool. As with any other complex financial strategy, clients should seek advice from life insurance, legal and accounting professionals. For questions or to learn more about private placement life insurance, please contact Hester Insurance Group.
Who Should Consider
Private Placement Life Insurance?
-
Persons Who Favor Highly Tax-Inefficient Investments
-
Persons Who Live in High Tax Jurisdictions
-
Persons Who Wish to Protect Against Premature Death
-
Persons Wanting to Access Both Non-U.S. and Domestic Investments
Disclosures
This material is intended for informational purposes only and is not an offer or solicitation to purchase any securities or investments. Private Placement Life Insurance should only be presented to Accredited Investors or Qualified Purchasers as described by the Securities Act of 1933 and Investment Act of 1940.
Private Placement Life Insurance involves the investment risk of securities that include loss of value or total loss. Risks may include liquidity restrictions, lock-up periods, early redemption fees, transfer restrictions as well as other penalties that may apply to the underlying investments or securities. Additional risks could be associated with but not limited to government regulations that impact certain industries, changes in interest rates, pricing movement and transaction costs. Investments will fluctuate based on factors that include among others: performance, investment strategy, withdrawals and contributions. Actual investment results and performance will vary and are not guaranteed.
This document is not intended to constitute tax or legal advice and does not replace the professional advice of an attorney or tax advisor. Investors should consult with their own independent legal and tax advisors. Any tax and legal references herein are designed to provide accuracy with regard to subject matter. Hester Insurance Group LLC is not engaged in rendering tax or legal services.
The financial graphs/data in this document is purely hypothetical and solely for discussion purposes. Any illustration is not intended to predict or project future performance nor representative any actual investment results or performance.
Private Placement Life Insurance is entered into between the investor/policy owner and the insurance company. Policy owners should read the Private Placement Group Annuity Contract thoroughly.
Investors should consider the following before investing in Private Placement Life Insurance: 1) investment objectives, 2) risks, 3) charges and expenses of any variable product before investing. A Private Placement Memorandum offering will include this and other important information about the investment company.
Securities offered through Spearhead Capital, LLC, a Registered Broker/Dealer, member FINRA/SIPC.
Hester Insurance Group LLC is independently owned and operated.
© 2020 JERRY W. HESTER, II. HESTER INSURANCE GROUP LLC. ALL RIGHTS RESERVED. FOR ADDITIONAL INFORMATION PLEASE CLICK HERE.