Inflation, stock market volatility, and geopolitical issues have posed financial challenges to people in all financial brackets. However, there are still ways that wealthy individuals can control their taxes on their investments and the taxes their families will be responsible for when they pass away.
One popular tool for wealthy individuals is private placement insurance. This type of insurance is designed for wealthy people in higher tax brackets who can commit a few million dollars to an investment. It allows for the deferral of state and federal income taxes on investment portfolios.
Why Some Choose Private Placement Life Insurance
It is a more attractive alternative to a hedge fund for many wealthy individuals, given the tax repercussions. When investing in a hedge fund in their name or that of a trust or tax account, every trade could create a capital gains distribution, while ordinary income from it sees a very high tax rate. At higher income levels, the combination of capital gains taxes and federal and state income taxes could see them paying out as much as half of what they make.
Therefore, many wealthy people find that holding these assets in a life insurance policy is a more sensible approach. In short, it combines the financial advantages of investments such as hedge funds that are highly taxed with the tax advantages of life insurance.
What is Included with Private Placement Life Insurance?
This type of insurance is made up of an investment portfolio and an insurance component aimed at delivering the minimum amount of insurance protection with the lowest cost possible to maximize the tax benefit.
It may be structured in a way that allows it to include private equity funds, hedge funds, and stocks and bonds. The policy’s cash value can grow free of income tax, and if an irrevocable trust owns it, the portfolio’s life insurance benefit could potentially avoid federal estate tax. This can amount to significant savings given that it currently has a top rate of 40 percent, much higher than the other alternatives.
By deferring and potentially eliminating the taxes associated with other types of investments, the money can grow and compound faster.
Who Should Consider Private Placement Life Insurance?
Individuals with an annual income in the millions of dollars or a net worth in excess of $20 million are good candidates for this strategy. Wealthy investors in very high tax brackets who were planning to invest in a hedge fund anyway often find that doing so via a privately placed life insurance policy shelters them from taxes.
Although administrative and insurance costs are involved with the life insurance contract, the tax savings and death benefit itself will more than outweigh these additional fees. Moreover, the insured can access most of these funds tax-free via policy loans and withdrawals, which in the long run, is beneficial for high-earners.
What Is Private Placement Life Insurance?
Private placement life insurance (PPLI) is considered an unregistered securities product, which means that agents may only offer them to accredited investors. Regulations outlined by the Securities and Exchange Commission define accredited investors as individuals who have a net worth of more than $1 million (excluding their primary residence) or an income of $200,000 or more during the preceding two years. For married couples, the couple must have an income of $300,000 during the previous two years.
In addition to having a high net worth, the typical PPLI candidate will be able to find at least a million dollars worth of annual premiums across a span of several years, although $3 to $5 million is typical. This significant investment in the first few years is necessary because if the underlying investment subaccounts perform sufficiently well, the policy can become self-funding because the growth in its cash value can cover the cost of the insurance itself. The insured will then be able to stop committing premiums to the policy if they desire.
How Does It Work?
A privately placed life insurance policy will usually be structured as a variable life insurance policy. This means the premiums will be flexible, and the insurance cost will be subtracted from the policy’s subaccounts’ cash value on a yearly or monthly basis. If its cash value reaches zero, the PPLI policy will lapse.
These policies are normally set up to maximize their cash value accumulation while minimizing the death benefit and, by extension, the insurance cost. The owner will then pay as much premium as they can each year. They will enjoy benefits such as tax-deferred growth of cash value, tax-free death benefits to their heirs, and tax-free growth on any dividends.
Learn More About Private Placement Life Insurance Policies
To learn more about how private placement life insurance policies can benefit you, contact the insurance professionals at Vector Financial Group.