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Time to take a second look at Private Placement?

Updated: Nov 2, 2023


Private Placement Life Insurance (PPLI) has garnered a lot of attention lately, and for good reason. Considering the ever-changing landscape of taxes, investments, and estate planning opportunities, PPLI can be a multi-purpose planning solution for many Ultra High Net Worth (UHNW) families. There are three factors that make it more attractive today than ever before:


- The likely prospect of increased tax rates in the future

- Improved investment flexibility and optionality within PPLI policies

- Updates to IRC Section 7702 and more competition in the PPLI space



What is Private Placement Life Insurance?

PPLI is a type of life insurance policy that is designed for wealthy individuals who are looking for a way to protect and grow their assets while maintaining access to alternative or custom-tailored investment strategies. PPLI is typically built on a variable life insurance chassis, which means that the policyholder can invest policy cash value in a range of investment options, for example, stocks, bonds, and alternative investments like hedge funds and private equity funds.

The advantage to owning these assets inside this insurance “wrapper” is that they grow tax-free, and the death benefit (which is highly correlated to the performance of the investments) passes to the policy beneficiaries tax-free. The insured may also access policy cash value during their lifetime on a tax-free basis, if distributions are made properly. This allows investors to avoid K1s, capital gain taxes, and any ordinary income tax on investments gains within the PPLI structure.



Tax Landscape

After years of historic US government spending, many advisors and investors feel there has to be an economic balancing that will likely lead to higher taxes in the near future. The prevailing consensus is that wealthy Americans will bear that tax burden more than most. Since the ideal PPLI clients are often the biggest targets for these increasing taxes, they would be wise to plan proactively. Some of the biggest concerns that our clients have right now are the disappearance of stepped up basis; the estate tax exemption sunset in 2026; and the narrowing gap between ordinary income and long-term capital gains tax rates. By removing assets from a taxable environment, PPLI can help families avoid the worst outcomes of these potential tax changes.



SMA Prevalence and Expanded IDF Offerings

In the past, wealth advisors have been slow to adopt PPLI because of its limited investment options. Funds approved for use in PPLI policies, known as Insurance Dedicated Funds (IDF), are costly to create and administer on a one-off basis. And only a relatively small number of readily available IDFs existed on the market. However, in recent years, independent advisors have been able to efficiently set up separately managed accounts (SMA) within PPLI policies that allow them to continue managing their clients’ investments with the same strategy and care they are accustomed to. Using the SMA structure requires a much lower asset threshold for the policy than creating a one-off IDF, yet maintains the benefits of an individually tailored fund. Advisors managing PPLI-owned SMAs are free to allocate to high-growth, tax-inefficient assets and pursue various investment strategies without regard to taxation. 2022 was a case in point: although many advisors wanted to shift from growth to value stocks in their clients’ portfolios, they were constrained by the tax consequences of selling those positions. Even as SMAs grow in popularity, more and more hedge funds, BDC’s, private debt funds and private equity funds have been launching “retail” IDFs, giving non-SMA clients more optionality among alternative asset types.



7702 and Insurance Companies

PPLI policies are designed to minimize the death benefit-to-premium ratio, so as to maximize the cash allocated to the policy’s investment component. At the end of 2020, a new law pertaining to IRC Section 7702 (which governs the relationship between death benefit and premium) decreased the amount of relative death benefit required to comply with the Code. This made PPLI even more efficient as a cash accumulation vehicle by reducing overall insurance costs and allowing more of the premium to be allocated to the underlying funds.

Because of these trends, well-known insurance carriers like Prudential and Zurich, who have great retail insurance products, have made their way into the PPLI space. This market competition has made the underwriting PPLI much easier and more attractive for clients.

Overall, PPLI is a great strategy for the right type of client. For most scenarios, the perfect PPLI fit is someone with net worth of at least $15 million or income of at least $3 million annually, who is looking to deploy liquidity today and hold it for at least 8 or more years. It is also a great way for clients to avoid taxation on assets they intend to pass on to future generations or charitable causes, while maintaining full access to those funds during their lifetime.



 

Warren McGuire joined NFP as a Director in 2018. In this role, he works with professionals, business owners, and high net-worth individuals, advising them on strategies for asset accumulation and wealth preservation.


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