Submitted by Mark T.
Wealthy investors, including family offices, are increasingly leveraging private placement life insurance (PPLI) as a way to to make investing more tax efficient. PPLI enables wealthy investors to invest in hedge funds and other vehicles tax efficiently by allowing for tax-free accumulation and tax-free access to policy cash values.
PPLI has its roots in the development of variable universal life. Historically, life insurance has been broken down into two types – term and permanent – with term and whole life products representing the most traditional forms of coverage and with the investing done for these products managed by the carrier. It wasn’t until the mid-20th century that life insurance and annuity products with do-it-yourself investment options emerged. Indexed and variable annuities and universal life products gave policyholders the option to earn higher rates of return by tracking equity indices and buying mutual funds within the polices. The investment upside of these products, combined with their tax-deferred growth and tax-free estate transfers, made them attractive vehicles for retirement or estate panning, akin to 401(k) plans and IRAs.
Within this range of life insurance products is the variable universal life option. This offers the same perks and follows the same regulations as universal life, except the cash from the premium can be invested in an array of assets. PPLI is one form of variable universal life.
PPLI exclusively benefits the wealthy because clients must be qualified purchasers – a person with not less than $5M in investments – and accredited investors – at least $200K individual or $300k joint income or net worth exceeding $1M or participation as a partner, officer or director in the offering.
Once an individual buys a private placement variable universal life policy with, for example, a $20M death benefit and $1M annual premium, the carrier sets aside the $20M in death benefits. After taxes and insurance fees have been paid, the premium is then invested in an array of alternative investment instruments chosen by the client. This asset is managed by a hedge fund or other asset manager and grows tax-free in a cash value account. At any point in time, the policyholder can borrow against the cash value account, tax-free for personal use at a minimal interest rate. When the client dies, the carrier pays the $20M in benefits, tax-free (less cash value and outstanding loans) to the policyholders’ estate. See Figure 1.
Many different types of financial service providers are involved in the structuring and use of PPLI. See Figure 2. Financial advisors, wealth managers, brokers, insurance carriers, asset managers and reinsurers all play a role in the PPLI value chain and can profit from a better understanding of this often undiscovered hybrid insurance / investment vehicle.
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