Let’s explore a rarely talked about life insurance product for high-wealth individuals and families. Briefly, the life insurance industry has experienced its share of twists and turns over the years. None more than the niche product, private placement life insurance (PPLI). However, this wealth management strategy isn’t for everyone. Many family offices consider PPLI as a valuable estate planning tool for their ultra-wealthy clients. But, do the tax benefits outweigh the audit risk for qualified purchasers of this product/strategy? Perhaps that partially explains the hush-hush surrounding it for the past two decades. Even if PPLI isn’t what you need right now, it’s never a bad idea to learn about trending approaches to financial planning — plus, you might need it one day. Let’s dive in.
What Is Private Placement Life Insurance?
As the most tax-advantaged financial product, life insurance experiences loads of attention (and lobbying) every time tax reforms loom. Private placement life insurance is a customized niche product developed as a solution for complicated financial issues. Understanding the purpose of PPLI means knowing why it has taken flight recently, so let’s rewind to the Trump Administration days.
Amid a flurry of executive orders in 2017, then-President Trump signed into law the Tax Cut and Jobs Act (TCJA). This tax reform decreased the tax rate for high net worth individuals and couples. For example, couples making $470,701 or more were only charged a tax rate of 37% instead of the previous rate of 39.6%.
This particular tax reform will expire in 2025. For now, the new tax rates for U.S. citizens are 10%, 12%, 22%, 24%, 32%, and 37%. Keep in mind, expectations and reality always vary when it comes to tax reforms. One outcome remains the same throughout history; tax reforms always motivate people of all financial statuses to hunt for ways to protect their hard-earned cash. During this specific reform, private placement life insurance found its most defined purpose yet.
Understanding a Niche Product
Although PPLI has experienced a “start and stop” life cycle, high network individuals — with a few million to spare — now embrace its usefulness. Private placement life insurance is a customizable investment product designed to offer the death benefit and tax advantages wrapped up in one low-cost policy.
Remember, PPLI is a very niche product. Only a specific group of wealthy individuals can obtain this policy, mostly because it solves a very particular wealth management issue. High net worth individuals most often invest in hedge funds and other investment options; however, hedge funds have hefty taxes.
For example, when wealthy individuals invest under their personal name, it’s not uncommon for them to lose nearly 50% of their earnings to federal and state income and capital gains taxes. Individuals facing this type of loss are known as tax-inefficient. Furthermore, this loss is a genuine issue for the wealthy — but private placement life insurance works to protect these assets.
According to Edward A. Renn, a partner in Withers Bergman and featured in Forbes, “For over two decades, one of the best-kept secrets in tax planning has been private placement life insurance, which makes it possible for a hedge fund investor to capture returns tax-free.”
How Private Placement Life Insurance Works
In comparing retail life insurance products to PPLI, the most similar would likely be a variable universal life insurance policy. Sometimes, PPLI is known as private placement variable life insurance because of the two products’ alikeness.
Of course, not everyone can purchase a PPLI policy, mostly because of its distinguishable characteristics. Let’s talk about these moving parts and how PPLI works.
As mentioned, high net worth individuals rely heavily on investments to manage their wealth. PPLI includes plenty of investment options, allowing the policyholder to customize them within the policy. Consider hedge funds, commodity funds, real estate investment trusts, private equity funds, and venture capital, to name a few.
Naturally, the Internal Revenue Service (IRS) still maintains standards regarding investor control, insurance, and diversification. As an example, once the PPLI policy is signed, the IRS restricts the policyholder from influencing the insurance company’s investment decisions. It’s a well-known “hands-off” rule that PPLI policyholders must abide by.
Regarding insurance, insurance-dedicated funds (IDF) can be sold and replaced with other qualified investment products without tax consequences. And an investment portfolio must contain at least five distinct investments — meeting diversification rules, of course — for it to qualify as life insurance.
For several reasons, including reduced costs and regulations, offshore private placement insurance companies provide service for many policyholders. Luxembourg, Ireland, Liechtenstein, Singapore, Puerto Rico, Cayman, Barbados, and Bermuda are famous for offering PPLI products. Strangely enough, accessing PPLI funds isn’t nearly as much of a headache as you’d think.
The policyholders set premium payments, so they can pay as much or as little as they want. The most critical factor is that the policyholder must pay enough premium to maintain enough cash value because insurance costs are deducted from the policy’s cash value. The policy will lapse if the policyholder depletes the cash value.
That said, policyholders can make tax-free withdrawals up to the basis of the policies. Another option is to borrow against the cash value, which requires no underwriting or credit check. Plus, interest rates are usually low because the previously mentioned premium payments secure loans. Although the loan doesn’t have to be repaid, most policyholders replenish funds to maximize long-term tax-free growth.
Private Placement Life Insurance Carriers
Private placement life insurance originates in the United States; however, many U.S. policyholders use offshore carriers. Cayman, Puerto Rico, Barbados, and Bermuda are the most common areas to offer PPLI. Non-U.S. carriers are increasing in popularity because of the strict rules and regulations that pertain to insurance products here in America. Asia, Europe, and other areas of the world aren’t so restrictive.
Additionally, offshore carriers have lower overhead, pricing services as providers instead of traditional insurance carriers. Offshore carriers typically don’t engage in marketing or advertising. Plus, these carriers face plenty of restrictions with regards to their sales force. Naturally, these savings are effortlessly passed on to wealthy clients (i.e., lower commissions).
Some of the leading PPLI policy and insurance-dedicated fund providers are Zurich, Wells Fargo, John Hancock, Pacific Life, and Crown Global. But the most prominent provider of PPLI is BlackRock. What’s more, this provider purchased Philadelphia Financial Life Assurance Company and then merged with Lombard International to create the world’s largest asset management company. BlackRock has been a game-changer for private placement life insurance.
As mentioned, wealthy individuals are tax-inefficient, meaning they often face the risk of heavy taxation on their assets — but PPLI offers solutions.
Although Trump’s tax reformations lowered tax rates for high net worth individuals, most single incomes over $500,000 are taxed 37%. Add in state and local income taxes, and some individuals and couples deal with a 50% tax bite.
However, private placement life insurance maximizes its tax advantage strategy. For example, PPLI provides a tax-free death benefit and dividend growth, plus tax-deferred cash value growth. To sum up, this policy converts highly tax-inefficient investments (i.e., hedge funds) into highly tax-efficient ones for wealthy investors.
Customized Investment Strategy
Besides tax advantages, PPLI policies are customizable —within specified limits. That said, a PPLI investment portfolio often has significant drawdowns because of stock market volatility. Many policyholders contribute more money to the portfolio to keep it in force during market dips. PPLI investments often include various hedge funds or mutual funds, whereas equity-based investments aren’t typically suitable.
Unsurprisingly, high net worth individuals face vastly different issues than low-income individuals. One particular problem is protecting assets for their relatives and heirs. When investments, savings, and income are taxed heavily, much of the wealth disappears swiftly. PPLI policies can offer tax-free wealth growth as well as secure estate protection for the future.
Additionally, a policyholder can access cash values penalty-free and use that money at any age for any reason. This approach is vastly different from IRAs or annuities, for example. The best part is that policyholders don’t have to comply with minimum distribution requirements as there aren’t any.
To top it off, most offshore jurisdictions specify strict confidentiality and privacy regarding insurance policies. Perhaps, this aspect is one of the most attractive parts of PPLI. Besides, many offshore countries, like the areas mentioned earlier, have established insurance laws and regulations, providing protection and flexibility to policyholders. For example, Cayman Island has enacted confidentiality laws that offer protection against frivolous claims.
Plus, every U.S. state offers substantial asset protection — unlimited in some. Not only does cash value life insurance protect assets against creditors, but if held offshore, it keeps it away from the U.S. courts.
Best Candidates for PPLI
Private placement life insurance only works for a specific group of people, specifically those with a lot of money on hand. Wealth management firms work with family foundations, trusts, wealthy families, and corporations to create helpful life insurance plans to decrease tax burdens.
Under the Securities and Exchange Commission (SEC) rules and regulations, only specific individuals qualify as an “accredited investor” or a prime candidate for PPLI. For instance, individuals must have a minimum net worth of $1 million, not including their primary residence, or a minimum income of $200,000 for the past two years. For couples, the minimum annual income is $300,000.
The policyholder or owner is typically an individual, but it can also be a Trust. Using a Trust to hold the policy helps keep the policy clear of the individual’s taxable estate, decreasing estate tax liability. Of course, only an individual can access cash before death, so using a trust means giving up accessibility rights.
Typically, to purchase a PPLI policy, the potential policyholder must contribute $500,00 to $1 million to the policy. After that, most policyholders must transfer several million each year — $3 million to $5 million is standard. However, some use that money via withdrawals or policy loans and then replenish the funds, so the fund varies from time to time.
Nevertheless, typically qualifications for a PPLI policyholder are as follows:
- High net worth individuals
- Need to protect assets from creditors
- Highly tax-inefficient investments
- High federal, state, and local income taxes
- Willingness to face hedge fund or other investment risks
Naturally, not everyone falls into this category of wealth; however, PPLI isn’t going anywhere soon. For those who fit the bill, private placement life insurance could protect your future more than any other insurance product.
Take the Next Step
It’s tough knowing how to protect your family after you’re gone, especially with such a vast amount of information out there. But we can help!
To support you as you safeguard your financial security, I’ve created an up-to-date guide for parents who need life insurance here. My guide can help you with your long-term life insurance goals, especially with a family to nurture at home.
Here at CB Acker Associates, we want to help you take care of your family. If you’re ready to find a policy that fits your needs and your budget, we can help!
With access to all the top-rated life insurance companies, we work extra hard to get you the best life insurance rates possible. You can even compare rates and benefits from over 40 providers with no obligation to buy here. Plus, it’s fast—under 60 seconds kind of fast.
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