Who Should Consider A PPLI?
Families with an allergy to income taxes and an appetite for tax-inefficient investments or investment strategies are prime candidates for Private Placement Life Insurance (PPLI). Owners of PPLI, whether an individual, irrevocable trust, or limited liability company, must meet the accredited investor and qualified purchaser requirements.
Because of the life insurance component, medical insurability is a requirement, otherwise the insurance costs can eat into the tax savings benefits, making the strategy less appealing. However, in situations where medical issues do make buying life insurance impractical, you can consider PPLI’s close cousin, the Private Placement Variable Annuity (PPVA).
What is a PPLI?
PPLI is a special type of life insurance structured to have a high cash value compared to a relatively low death benefit. To minimize fee drag, the life insurance component is kept as low as possible, allowing the cash value of the policy to ultimately drive death benefit.
The goal of PPLI is to quickly build up significant cash value within a life insurance policy in order to take advantage of the tax-free treatment of income and gains from the underlying investments within the policy. While PPLI is built on a life insurance chassis, PPLI is first and foremost an income tax strategy for investing, not an estate planning one.
Essentially, it is a variable life insurance policy that allows you to allocate to alternative investments which wouldn’t be available within the more traditional variable universal life policies.
Where to Own a PPLI?
Because the primary goal of PPLI is not estate tax minimization, many investors will own these policies directly, inside of their taxable estate. To the extent sufficient assets are available that are not subject to federal and state estate taxes, certainly owning PPLI in an Irrevocable Trust is possible and preferred.
For clients who are leaving a significant portion of their assets to their private foundation at death, but aren’t ready to irrevocably give up personal access to those assets, investing through PPLI or PPVA can accelerate the process of making those assets effectively income tax-free. The PPLI or PPVA policy would be owned directly, inside the taxable estate. At death, the death benefit is paid out in cash. The value of the death benefit going to charity, which has grown income tax-free, will also pass estate tax-free.
Another application is in conjunction with a Grantor Charitable Lead Trust (CLT). When you fund a CLT, you are able to take an immediate tax deduction, in exchange for including future years’ income generated by the CLT on your personal tax return. A PPLI or PPVA policy can minimize that flow-through income back to you, allowing you to have the benefit of the upfront deduction, but not the continued phantom income.
Why (not) Consider a PPLI?
One of the key requirements to meet IRS guidelines on PPLI involves the policyholder giving up investment control over the underlying assets.
There are many investment options available, in the form of commingled funds, already approved on each carrier’s platform from which a policyholder can choose. In addition, some insurance carriers allow for managed accounts. In these instances, you do have the ability to choose among strategies, and investment objectives, but not individual holdings.
If the IRS deems that you, the investor, have too much control, the PPLI will be treated as if it had never existed in the first place and all income tax benefits will be erased.
A hands-on investor who is not comfortable handing over control of a portion of their investment portfolio may have a hard time getting comfortable with this strategy.
How (much) to Invest in a PPLI?
Sizing of assets dedicated to this strategy is important. Too little, and the benefits are outweighed by the costs. Too much, and liquidity issues can present problems.
No more than 20-30% of a portfolio should be allocated to PPLI, though other illiquid assets in the portfolio need to be taken into consideration in this calculation as well.
We advise clients to fund PPLI with at least $10m to make the investment and complexity worthwhile. This number is largely driven by underlying investments, since many of them tend to be hedge funds with their own minimum funding requirements.
While you can access these funds once invested, that shouldn’t be the plan going into a PPLI policy. There are a few ways to get at the funds invested within a PPLI policy:
- Cash withdrawal: Like any life insurance policy, withdrawals of cash are deemed to be a return of premium and are not taxable up to the total premiums paid. Withdrawals beyond premiums paid are taxable as ordinary income. Note the death benefit decreases based on the amount withdrawn.
- Borrow from the policy: For short-term liquidity needs, rather than withdraw cash, you can borrow funds from the policy at a reasonable cost of approximately 35 basis points per year.
- Borrow against the policy: The PPLI policy can be used as collateral, like other alternative investments, by some lending institutions. This method is generally limited to 50% of the policy.