Unique Private Placement Insurance Solutions For Unique Investors

Richard M. Smarg, AEP, CLU, CHfC, RIA
Naples, Florida – Estate Planning Council Supplement – March 2012

As income taxes may be increasing, affluent taxpayers are acutely aware of the tax burden on their investment returns. Private Placement Variable Life Insurance (“PPVUL”) offers unique access to investment returns in a tax-efficient environment.

Déjà vu: PPVUL is not new! Traditional life insurance offers numerous tax advantages (IRC Section 7702); including cash value tax-free build-up, tax-free withdrawals (assuming non-Modified Endowment Contract status), income-tax free death benefits and efficient generational wealth transfer. Similar to retail Variable Life, PPVUL premium payments are held in separate segregated accounts (“Separate Accounts”). Investment funds (“Investment Dedicated Funds” or “IDFs”) are selected from those offered by the carrier.

Tax Advantages: Nontraditional hedge funds strive to attain low-correlation to traditional investment markets, and risk-adjusted absolute returns (Alpha). To achieve these objectives, hedge fund managers typically employ high turnover trading strategies. Unfortunately these tax inefficient strategies generally lead to such higher current taxation it may cause affluent investors to limit their use of such funds. Combining PPVUL with nontraditional investment options such as hedge fund strategies provides unique insurance solutions for high net worth investors seeking alternative investment options on a tax favored basis. If properly executed, investment gains remain tax free - representing the perfect compliment to hedge fund investments. PPVUL policies can offer the same returns as managed hedge fund accounts with one key advantage – the returns of the “outside” investment are often taxed at ordinary income tax rates.

Requirements: PPVUL occupies a unique place in the financial products spectrum. However, purchasers must meet the Accredited and Qualified Purchaser requirements under SEC Regulations. To receive the unique tax advantages of life insurance, a minimum death benefit (“amount at risk”) must be maintained. The carrier must segregate the Separate Account assets from General Account assets – protecting these assets from the carrier’s creditors. To qualify for the income tax advantages, the IDFs must satisfy three requirements (access to IDFs must not be available to the general public; Separate Account assets must be adequately diversified under IRC Section 817 (h); and the product must satisfy the “investor control doctrine” limiting the amount of control the owner can exert).

Low-Cost: Compared to the benefits, PPVUL costs are small. For example – conventional retail policy first year premium expenses can range from 70% to 90%. PPVUL policies have minimal fees – often less than 1%. Economies of scale enable specialty carriers to charge lower mortality and M&E fees on PPVUL policies. Since premium tax, state regulations and creditor protection statutes vary from state to state, affluent investors may chose to acquire PPVUL policies through trusts or entities in another state jurisdiction.

Unique Insurance Solutions for Unique Investors: Investors with large investments in tax-inefficient asset classes may benefit from PPVUL investment accounts. Typically, there should be a need for significant life insurance, perhaps to fund tax-efficient multi-generational strategies, or to seek long-term retirement income. In most states PPVUL’s unique “asset protection from creditors” may represent a viable alternative to placing assets in offshore trusts. PPVULs are ideal for those who want to retain ownership and enjoy access during their lifetime. PPVUL funding can also facilitate many charitable planned giving opportunities.

Benefits Mitigate Complexity: The complexity of PPVUL policies and their corresponding threshold requirements, dictate that advisors understand the economic, legal, and tax implications. The acquisition of PPVUL investment accounts requires an insurance firm experienced with this unique product market, having the resources to provide jurisdictional guidance, carrier selection, product design, ongoing administration and reporting services. If established and monitored properly, PPVUL offers the opportunity to access life insurance and investment funds within a tax-efficient structure.