Individuals with a high net worth seeking a way to grow and transfer their wealth without losing too much of it to taxes can take advantage of a private placement life insurance policy. Here is a look at what is involved in this approach and how it can help to create value through tax savings and cash value accumulation.
What Is Private Placement Life Insurance?
A private placement life insurance (PPLI) policy is a specialized type of insurance that carries a high cash value with a low death benefit. The life insurance component of a PPLI policy is intentionally kept as low as possible to keep fees down and enable the cash value to drive death benefits. This allows individuals to amass a significant cash value in the policy that can take advantage of life insurance’s tax-free treatment of income and gains from the policy’s underlying investments.
With a PPLI policy, high-earning American taxpayers can accumulate earnings free of income tax across several years, the compound effect of which can be significant. At the same time, they will still be able to appoint an investment manager and invest the funds as they wish.
A private placement life insurance policy owner will work with their advisor to choose specific investments for the portfolio. In addition to hedge funds, these can include private equity funds, real estate investment trusts, venture capital, commodity funds, and other approaches. However, they must meet diversification requirements that state that no single investment can account for more than 55% of the subaccount portfolio, and no two investments can make up more than 70% of the portfolio.
Wealthy individuals who hold this policy for life and whose investments perform well can accumulate a significant amount of cash value without having to pay taxes along the way. The death benefit of such a policy will be transferred to their heirs in a manner free of income taxes.
How Does Private Placement Life Insurance Create Value Through Tax Benefits?
High-income individuals face very high taxes, with state, local, and federal income taxes combined, often amounting to nearly half of some people’s income. PPLI serves to convert tax-inefficient investments that high-net-worth individuals are drawn to, such as hedge funds, into highly tax-efficient approaches.
For example, if a wealthy individual were to obtain a hedge fund on their own or through a trust, they would be responsible for paying considerable taxes. When a hedge fund is purchased through a private placement life insurance policy, however, the policyholder enjoys benefits such as flexible premiums, tax-deferred growth of cash value, tax-free growth of any dividends, and death benefits to their heirs that are not subject to taxation.
At the same time, the policyholder will continue to have access to the policy’s accumulated cash value, which they can either withdraw directly at any age without a penalty or borrow against in the form of a policy loan with a very low-interest rate if needed.
In cases where a PPLI policy is set up to be owned by an irrevocable trust, the life insurance benefit attached to the portfolio could avoid the federal estate tax, which can be as high as 40%.
Who Qualifies For A PPLI?
A PPLI is a very attractive option for individuals with high net worth, but it is only appropriate for some. A good candidate for this strategy is an individual whose annual income is in the millions of dollars and who has a net worth of at least $20 million.
As an unregistered securities product, current regulations set by the Securities and Exchange Commission state that agents may only present a PPLI to “accredited investors.” These individuals have a net worth of at least $1,000,000, excluding their primary residence, or an income that exceeded $200,000 in each of the previous two years. For married couples, the income must have exceeded $300,000 during each of the previous two years.
Interested individuals need to be able to make a significant investment during the first few years because this initial investment will be what helps the policy remain self-funding in the sense that its growth in cash value will be enough to pay for the policy itself. This will free the policyholder from having to commit more premiums if they so choose.
Schedule A Consultation With The Specialized Life Insurance Experts
Individuals with a high net worth or annual income must make careful decisions about where to invest their money and protect their wealth. To learn more about how a private placement life insurance policy can serve your overall financial plan, schedule a consultation with Vector Benefits to discuss our insurance brokerage and financial planning services geared toward high-net-worth individuals.