The right kind of insurance can mitigate tax exposure and maximize legacy-building
No matter the length of your balance sheet, preserving the wealth means being smart about how your investments are structured to minimize tax exposure, both in life and as you look to pass wealth on to the next generation. Some of the best investments for tax efficiency might be a specialized kind of insurance.
“Private Placement Life Insurance (PPLI) policies have existed for quite some time and have become increasingly popular with wealthy individuals seeking to mitigate tax exposure,” says Whittier Trust Assistant Vice President for Client Advisory Shea O’Gara, J.D. “PPLI policies provide a unique solution for holding tax inefficient investments while maximizing intergenerational transfers of wealth.” Generally, PPLI is most suitable for accredited investors including high net worth individuals, banks, brokers, and trusts.
PPLI attempts to couple the tax advantages of Variable Universal Life Insurance (VUL) with the growth often associated with alternative investments. This renewed interest in PPLI is largely being driven by wealthy individuals in top tax brackets, with good reason. For instance, in certain circumstances top earners in California and New York can face a combined federal and state income tax rate in excess of 50%. Additionally, assets above the federal estate tax exemption can be subject to a 40% death tax. When structured appropriately, PPLI can mitigate both income and estate tax exposure.
“While a PPLI does offer some estate planning opportunities, the main focus is to capitalize on the tax-free treatment of income and gains produced within the policy,” O’Gara says. Because PPLI incurs no immediate income tax, there is no need to wait for a Schedule K-1 to report the incomes, losses and dividends of a partnership.
“PPLI stands in contrast to traditional life insurance policies in many ways, but perhaps most notably it provides an opportunity for the insured to hold non-traditional investment positions,” O’Gara explains. For example, a PPLI policy can consist of private equity, hedge funds, private credit and other alternative investments otherwise not accessible in a traditional life insurance policy. The policy usually contains a high cash balance affixed with a lower death benefit to reduce ownership costs. Although insurance costs vary when owning a PPLI, the long-term tax savings usually greatly exceed the policy cost.
A PPLI operates as an income tax mitigation strategy, but it can also serve as an estate tax strategy if structured properly. Ideally, the policy would be owned outside an individual’s taxable estate through an irrevocable trust. When the PPLI is owned by an irrevocable trust, the death benefit passes estate tax free. If an individual has yet to utilize their lifetime gift exemption, owning a PPLI in an irrevocable trust is a potential option. It can be a smart addition to an overall wealth management strategy, executed by a trusted wealth management advisor.
Notwithstanding a multitude of advantages associated with a PPLI, there are some drawbacks to consider. Mainly, (1) medical underwriting, (2) lack of control, (3) costs and (4) early surrender consequences.
- The individual insured must be in good health and willing to undergo a comprehensive review of medical records and insurance exam.
- An IRS investor control rule stipulates that the policy holder cannot influence the selection of individual securities held within the policy either directly or indirectly. However, policy owners dictate which funds their policy owns.
- Costs vary, but generally PPLI fees include a structuring fee, federal deferred acquisition cost tax, state premium tax, asset-based mortality expense charges, and cost of insurance charges. Initially, PPLI policies are fee intensive and in the short term could exceed the immediate tax benefits.
- Generally, there is no fee associated with surrendering the policy. However, tax may be owed on the appreciation of investments at an ordinary income tax rate.
PPLI is a nuanced solution that can be beneficial to high net worth individuals. PPLI requires a thorough analysis to determine if such a strategy is beneficial due to its complexity.