Many affluent people are unaware of a tax-free benefit called private placement life insurance, or PPLI. It can be simplified and described as this: an investment wrapped inside an insurance policy.
The private placement life insurance industry is valued between $4 and $5 billion. This figure suggests that it is a popular investment and tax strategy for wealthy households worldwide.
Unfamiliar to the average person and complex for even the savviest of investors, private placement life insurance is a legal way to park your money in hedge funds and other type of assets that does not require you to pay taxes on any of the capital gains or income.
Although the rules and regulations behind this tax strategy vary by jurisdiction, the United States Internal Revenue Code applies the taxation of the insurance quite differently than other forms of investments. You are not required to fork over a federal income tax and you are not mandated to pay a 15 percent capital gains tax when the holder of the policy passes away.
The cash value behind private placement life insurance, which is another measure of variable life insurance, does depend on the performance of the investments inside the policy. Nevertheless, the returns can be rather exorbitant considering that you generally use it to trade hedge funds, an investment that comes with a 35 percent short-term capital gain tax.
It comes down to this: the private placement life insurance is a taxable investment inside of a tax-free life insurance policy that holders can benefit from the compounded gains of the investment and the death benefits; all of this doesn't consist of a single basis point tax rate.
How PPLI Works
Let's take a look at exactly how it works:
High Net Worth Clients Need Help
A lot of wealthy investors resent the fact that they need to hand over a great percentage of their capital to the government. Whether it's through their hard work or their sublime calculations of the stock market, they will have to pay double-digit rates to the state to be squandered away.
The affluent person will comb through the numerous options to protect the household wealth.
With this in mind, high net worth clients will approach private bankers for assistance in ways to preserve their capital. Many investment vehicles will be put forward: annuities, mutual funds, tax-free savings accounts and the like. But this may not benefit a wealthy family at all.
Private Bankers Make a Recommendation
Since the high net worth client will need an instrument to park their funds without any hassle from the authorities, a private banker will make a recommendation: a private placement life insurance.
After explaining the details thoroughly and outlining the pros and cons, the high net worth client will be intrigued by the proposition. They will then crunch the numbers and determine just how money can be earned and saved without facing the consequences of high rates of taxation.
With the stock market surging and likely to do so for the foreseeable future, the rich customer will have their interest piqued by the potential lucrative earnings from the diversification.
Is this an Insurance Wrapper?
As previously mentioned, a private placement life insurance can also be likened to an insurance wrapper. The investment in hedge funds, for example, is wrapped inside of an insurance policy. The recipient of the insurance policy will garner the compounded investment gains and the death benefits.
Protect Your Deposited Assets
Much of the discussion behind private placement life insurance usually includes hedge funds. However, it should also be noted that the holder of the policy can also deposit other assets, like stocks, mutual funds, retirement funds and savings, into financial instruments.
By doing this, you can receive both tax planning benefits and asset protection. The latter is especially important to shield your private bank accounts from hefty taxation and inflation.
This is what you can expect when you're in the market for private placement life insurance.
The Tax Benefits of Private Placement Life Insurance
Now, let's look at the wide variety of benefits behind private placement life insurance:
No Income Tax
If you are earning a minimum of $200,000 in income then you are already paying a lot of taxes to the government at all three levels. With this level of income, you are facing a tax rate of at least one-third, and perhaps even more when you factor in state or even municipal income taxes.
When you own a private placement life insurance and you derive an income from such a pecuniary measure then the policy owner does not owe any income tax whatsoever.
Of course, the average person with a $40,000 annual income is not permitted to maintain such a life insurance policy - you may need to establish a $5 million PPLI based on the service that you utilize. Depending on where you live, you may be required to have an annual income of at least $200,000 in order to dive into this investment strategy.
No Beneficiary Tax
Like with other types of investments, should the holder pass away, the beneficiary will receive the money but be required to claim an income tax benefit. However, the beneficiary of your private insurance policy will not have to make such a claim and will not be obligated to pay a beneficiary tax. Whether they are getting $500,000 or $1.5 million, they are not mandated to pay the government a single cent.
No Estate Tax
As you get a little bit older and start examining your overall net worth, you begin to mull over the future of certain people in your life. They could be your children, your significant other, your nieces and nephews or that one town that changed your life for the better.
You construct a plan that will leave the beneficiary of your estate with an abundance of money.
The only thing you fear is that they will be taxed to high heaven. Fortunately, with the right private banker, the right attorney, the right planning and a private placement life insurance, you can ensure that your family, friends or beneficiary do not pay the much dreaded estate tax, or as some critics like to colloquially refer to it as, the death tax.
Now that you fully understand the benefits, you may be extra excited to allocate your resources to this policy.
With a private placement life insurance directive, it may seem like all sunshine and lollipops. It mostly is, but you should be aware of some of the, shall we say, negatives behind the method.
Here are a few things to be careful of as you transfer your funds into a PPLI:
The Fees You Will Pay
Indeed, nothing in life is free, and you can't get something for nothing. Once you initiate a private placement life insurance policy, you will be expected to pay for three primary charges: the premium load, the “mortality and expense” charge and the cost of insurance charge. The charges should vary between one and two percent of the total premium per year.
This may seem like a lot, but it should be noted that these investment fees are lower than some of the other alternatives out there.
Beware of the Hurdles of PPLI
There are a few hurdles you need to be aware of before you can invest in a PPLI:
- According to the Securities & Exchange Commission (SEC), you must be an "accredited investor” and “qualified purchaser."
- The insured must be medically qualified to be able to be a PPLI client.
- You will be required to select from the insurer's pre-selected list of bonds, hedge funds, stocks and other investments in which the premiums will be invested.
- Don't be sneaky; you can't try to stuff your private art collection or stamp collection inside the PPLI.
Do You Have the Financial Capacity?
Lawrence Brody, an estate planner, did issue a warning to the New York Times in 2011:
“You have to have the financial capacity to buy one of these, so that it’s not too tempting to have a $100 million policy on your life and somebody who’s a beneficiary who might want to kill you [to collect the death benefit]. You will want a billion or so in net worth, and the insurer will probably even require it.”
Considerations for Offshore Purchases
Are you going offshore for your PPLI? In that case then some of the aforementioned suggestions need to be completed offshore. For instance, when you undergo full medical and financial underwriting, it would to be performed offshore. The most typical place is Bermuda for Canadians or Americans.
Moreover, should you hold a policy by an offshore carrier, you need to have a foreign legal owner or you need to establish a foreign trust or company in order to fully own the policy.
A private placement life insurance is a great investment tool for the affluent. Although it is underutilized today, it is versatile and comes with great returns and protections in various ways. You don't need to worry about taxes, both in this life and in the next.
Akin to other tax-free strategies, it does require plenty of research, planning, calculations and professionals, like attorneys, doctors, accountants and bankers.
By employing the necessary measures and suggestions, you can be rest assured and confident that you have made the right investment decision with a private placement life insurance policy. Your wealth will protected and your family or your beneficiaries will be well provided for.