For those interested and able to invest in hedge funds or other alternatives, another option exists that can yield the same results with much less of the pain imposed by taxes. Private Placement Life Insurance (PPLI) is an asset protection solution used most effectively by individuals with a net worth of more than $20 million, income of several million dollars per year and/or owners of businesses generating significant income. Investors, in addition, must be comfortable relinquishing direct control over a portion of their assets to a financial manager, a strict and time tested requirement of PPLI. An investment of $500,000 is considered a minimum to realize a significant return and, in fact, is often required as a minimum investment.
PPLI is especially attractive because it avoids many of the taxes associated with other investment options (i.e. capital gains distributions or taxable income). The investment combines the potential upside of a hedge fund with the tax advantages of life insurance. (Of course, that same formula holds downside exposure.). The money that is invested inside of the insurance policy grows tax-free.
PPLIs continue to grow in popularity but remain an investment still off the beaten path. Their popularity is likely to grow even more in the near term as Congress rethinks estate and gift tax exclusions. In recent years, insurance companies, both on and off-shore, have expanded their PPLI offerings. Institutions offering PPLIs and insurance dedicated funds include: BlackRock, Wells Fargo Private Banking, John Hancock, Zurich, Crown Global and Pacific Life.
Here’s how it works:
An individual or trust buys a variable universal life insurance policy on the life of the investor. The premiums are generally flexible (often $!M – $3M per year) and usually front loaded to ensure that the investment generates maximum bang for the buck. An important caveat is that the policy owner cannot pay more than the total of premiums owed on the policy in less than seven years or the investment will no longer be treated as an insurance policy.
The money invested in the policy is held by the insurance company in a dedicated, separate account. In time, the policy should become self-funding using the money in the account to pay the premiums. The money is invested either in funds managed by the insurance company or may be managed by an independent investment manager. The owner of the policy, whether it is a trust or the insured, does not and must not directly influence the specific investments. They may, however, select very general investment parameters.
The death benefit and thus the actual cost of the insurance policy itself is kept low and the owner of the policy works with an insurance advisor to pay the maximum allowed premium to maximize the amount available for investment and growth. As a result the money invested in the policy grows tax free and the investor’s heirs ultimately receive a tax free death benefit. In addition, whatever is invested in the policy is not subject to estate taxes.
Here’s what makes PPLI an especially appealing proposition:
The policy owner or insured may withdraw from or borrow against the amount in the separate account without penalty. Loans have the advantage of being tax free and may be repaid by the heirs from the policy’s death benefit.
The benefits of PPLI investment can be extraordinary, but there are several cautionary notes that must be taken into account:
- Investor Control: As stated previously, the insured and/or the owner of the policy must not be involved in the investment decision-making process. The IRS means what it says here, and this requirement has been extensively litigated and opined on.
- Insurance Dedicated Funds (IDF’s): Funds that may be offered by insurers and others may not be open to the general public. They can mirror funds that are available more generally, but these funds must be dedicated to insurance investors.
- Diversification: There are specific rules on how money invested in policy must be invested. It’s clearly not acceptable to use a PPLI as a vehicle to simple investment in a single investment. Here are the rules:
- No single investment may make up more than 55% of the insurance subaccount portfolio.
- No two investments may constitute more than 70% of the portfolio.
- No three investments may constitute more than 80% of the portfolio.
- No four investments may constitute more than 90% of the total assets of the account.
Taken together, this means that there must be at least five investments.
That said, there are other, technical requirements that are required of PPLIs and must be adhered to in order for investments to qualify for favorable tax treatment.
For the right investors PPLI’s offer a tax efficient means to protect assets and to promote growth. If invested wisely there is the potential to realize significant growth. The one, most significant caveat is that the investor must be willing to cede direct control over how and where his or her funds are invested.