Is Private Placement Life Insurance Right for You?

With market volatility persisting throughout the year, investors have become more interested in alternative investments. Some of these investments, such as hedge funds, private equity, Real Estate Investment Trusts (REITs) and others incur large income distributions. For those in the top tax bracket that can mean income taxes near 45%, whether or not that income is received.

Private Placement Life Insurance (PPLI) is a unique vehicle for clients who find themselves at the top of the income tax ladder and have a desire to invest in the alternative space. PPLI allows individuals or trusts to take advantage of the tax benefits of life insurance while maintaining desired investment allocations. By transferring or purchasing these tax-inefficient assets within a PPLI policy, which can also be held in an Irrevocable Life Insurance Trust, high earning individuals can shelter the income produced by the assets and defer the tax on growth of the assets.

To qualify for this type of policy investors must meet the SEC standard for an accredited investor. Accredited investors are individuals with gross income of $200,000 in each of the two most recent years, or married couples with income of $300,000 in that same time period. Alternatively, individuals or couples with net worth, excluding their primary residence, greater than $1,000,000 also qualify. Typically, policies will require a minimum $1 million investment, but higher figures are generally recommended to maximize cost effectiveness.

PPLI is structured similarly to Variable Universal Life (VUL) policies: there is a minimum death benefit component and a cash value component. The death benefit is generally kept as small as legally possible in order to minimize costs on the policy. Unlike other cash value policies with limited investment options, PPLI policies permit a wide variety of investments. However, these investments need to meet minimum diversification standards in order to qualify as life insurance. While some carriers permit separately managed accounts (SMA), allowing the owner the ability to name individual managers, many carriers utilize Insurance Dedicated Funds (IDF) to ensure the diversification requirements are met. Many hedge funds tailor their product offerings to qualify as IDFs. Though a client can choose an IDF for investment, they may not control the investments within the IDF or direct a manager within a SMA.

Similar to other life insurance policies, the owner of the policy has access to the cash value of the policy through withdrawals or loans. These distributions are treated on a first in first out basis, meaning premiums paid are returned first and will not be taxed so long as the policy passes the “seven-pay” test. The test looks at the required cumulative premiums to fully fund the policy over a seven-year period. Meaning if the policy were to require $300,000 in premiums to fully fund, the premium cannot exceed approximately $43,000 annually for the first seven years, or the seven years after a substantial change to the policy. Such a change would effectively restart the testing period. This test was established to assist the IRS in determining whether a policy is overfunded. Should the policy fail the “seven-pay” test, it becomes a Modified Endowment Contract and loses many of the tax benefits associated with life insurance. Careful planning is required! Compared with other life insurance products, fees are deemed reasonable when scaled, with policies generally put in place with fees between 1-2%. Additionally, K-1s are no longer assigned to the policyholder but to the insurance company, eliminating the need to file extensions for some clients.

So what effect may a PPLI policy have on the growth of your portfolio? The below chart takes a look at two similar investments grossing 10% income annually for 30 years. Investment A is located in a standard taxable account, being taxed at 45%, and disregarding fees for the purposes of this analysis. Investment B is located in a PPLI policy charging a 1% fee. No taxation occurs within the PPLI policy until the potential withdrawal of gains.

While the difference isn’t substantial in early years, we see that by year 10 we are creating a significant spread between investments. Nearly $4 million in additional wealth has been accumulated. By year 30 that figure grows significantly.

To summarize the benefits of PPLI:

Opportunity to shelter income and defer growth for tax-inefficient investments
Ability to invest in wider variety of investments while maintaining life insurance benefits
In Michigan, and most other states, life insurance offers protection from creditors
Ability for ownership by Irrevocable Trust, hence moving assets out of the estate
No age restrictions for access to funds (no penalty)
Minimize costs by minimizing death benefit (benefit can still be significant in larger policies)
Elimination of K-1s for personal taxes
Death benefit available to beneficiary

How about some disadvantages:

Not everyone qualifies for PPLI, must meet the accredited investor standard
Policies require large cash flows for several years to fund
The investor loses control of the investment decisions
Added cost of death benefit to investment
Complex with strict compliance standards
Diversification requirements

PPLI is a sophisticated planning strategy that may not be for everyone. However, for those that it does fit, now may be a good time to start investigating. As estate law changes loom, with lifetime exclusion amounts set to sunset in 2026, the opportunity to move assets out of your estate is closing. These higher growth assets are particularly well suited for PPLI and, if the policy is structured properly, can create immense savings for your family down the road. The ability to take back control of your reported income is appealing to most, the added benefits mentioned above may be enough to factor PPLI into your wealth management plan.

If you would like to learn more about PPLI and how it may benefit your situation, please reach out to a member of your client centric team.