Estate Planning Strategies

Private Placement Life Insurance (PPLI)

PPLI is a custom designed insurance policy which allows for the accumulation of monetary and asset values generated from non-traditional investments  which can also be distributed estate tax free to one’s heirs.

PPLI Investors typically share a common goal of sheltering significant taxable income by utilizing a customized approach towards asset management within the structure of a life insurance policy. Private Placement Life Insurance has similar attributes to a traditional variable universal life policy where premium dollars are invested into separate accounts, but unlike variable life insurance, PPLI is not required to be registered under SEC guidelines. Basically, a life insurance company will initiate a PPLI policy by establishing a contract with a policy holder, and typically this policy is designed to “minimize” the required amount of death benefits. The insurance policy will contain “separate accounts” which will invest the contributed insurance premiums and/or other contributed assets, and these assets are professionally managed for the benefit of the insurance company.

As a life insurance product, PPLI has the desired attributes of 1) Tax-free death benefits for your heirs, and 2) Tax-free growth of dividends and accumulated cash value. Ideally, the type of assets contributed to these policies have the ability to generate significant taxable income often accompanied by a growth in market value. It is the Life Insurance “structure” that enables enjoyment of the coveted benefits that include Tax-free death benefits and Tax-free growth which utilize these assets as an integral part of the policy’s cash value.

The main difference between PPLI and traditional life insurance, is that PPLI allows for the policy to invest in a diversified investment “structure” that may include non-traditional investments as opposed to traditional life insurance policies where premium dollars are invested and allocated solely into mutual funds contained within the segregated accounts of an insurance company. Non-Traditional investments often held within the separately managed accounts may include hedge-funds, private equity, registered mutual funds, fixed income, and commodity funds. Business and real-estate investments may also be managed within the separately managed accounts (SMA’s) or the subaccounts of a separately managed account.

Strict Requirements: The benefits of structuring a PPLI policy are many, however, it is important to state that this product and strategy must meet Internal Revenue Service requirements for minimum annual insurance death benefit levels, while abiding by the investor control doctrine, as well as asset diversification requirements . All can be met if the policy is structured correctly as well as periodically monitored for adhering to IRS requirements. That being said, the benefits of tax-free growth for your heirs as well as additional benefits covering asset protection from creditors can be significant.

Minimum Death Benefit Requirement: As a life insurance product, PPLI must maintain a minimum level of death benefits in order to qualify for and maintain the status of being a life insurance policy. This is necessary in order to retain the tax-free status and benefits that life insurance policies enjoy. The minimum annually required death benefit is typically based on factors that include the age of the insured as well as the fair market value of the investments (or cash value) that is held within the life insurance policy’s separate account(s). Internal Revenue Code section 7702 outlines specific testing protocols that define the required amount of death benefit relative to a policy’s cash value. PPLI typically utilizes the Guideline Premium Test as it generally results in a smaller death benefit in relation to policy cash values. When the Guideline Premium Test (GPT) is used, as defined by the code, a “corridor” or additional death benefit over and beyond the policy’s cash value is required in order for the policy to meet the total required death benefit to satisfy the definition of a life insurance policy and maintain the tax benefits that life insurance provides. As the age of the insured increases, the amount of insurance that is required will typically decrease, however if the applicable percentage of insurance required is applied against an increasing asset value, the total insurance needed may inversely vary by such factors. Since the policy owner does not need to be the same person as the insured, however, one can potentially design a policy where the required death benefit is minimized while maintaining the tax-free structure of the assets that may benefit from a favorable growth rate.

Investor Control Doctrine: Internal Revenue Service Regulations require that the insurance company, and not the policy owner, is the deemed owner of the assets that are invested in by the Insurance Company’s separate accounts. The policy holders can make suggestions, but may never select, direct, or control the investments or activities of the separate accounts. The manager(s) of the separate accounts are directly responsible for selecting investments within the separate accounts.

Diversification Requirements: In order for a PPLI contract to meet the diversification requirements under IRS code section 817(h), the separate investment account of the policy must as a minimum, adhere to the following guidelines:

a) No more than 55% of the value of the total assets of the account is represented by any one investment.

b) No more than 70% of the value of the total assets of the account is represented by any two investments.

c) No more than 80% of the value of the total assets of the account is represented by any three investments.

d) No more than 90% of the value of the total assets of the account is represented by any four investments.

An example of when Strategy meets Structure

Although numerous scenarios are possible, let us suppose that you own a business that is growing significantly in value and that you would like to freeze a portion of the business’s current valuation so that additional growth of the business will not be includable within your taxable estate. Your spouse establishes a Grantor (Irrevocable) Trust for the benefit of your children and adds a provision within this trust to provide you with lifetime health, education, maintenance, and support. (a concept similar to a Spousal Lifetime Access Trust or a Beneficiary Defective Inheritor’s Trust). He or she then “seeds” the newly established Trust with a cash gift by utilizing a portion of his/her allowable lifetime unified credit exemption. An independent trustee of this Grantor Trust decides to establish a private placement life insurance policy (PPLI) within the trust and deposits the cash value of this marital gift within the separately managed account of the PPLI. An independently appointed manager of the separate account utilizes the “seed” money as a down-payment in purchasing shares of your business in exchange for a promissory note that is payable to you over a period of years. Additionally, an appropriate death benefit is secured in accordance with the policy’s unique requirements. By selling a portion of the busines to the PPLI in exchange for a promissory note, several things are accomplished. First, the value of the business shares placed within the separate account of the PPLI is frozen for estate tax purposes so that any additional growth in valuation will not be subject to estate tax. Additionally, any earnings accumulation that is accrued from dividends will also be deferred. An additional opportunity for tax savings from minority discounts might also be achieved if shares of the business are placed into separate LLC’s (ultimately for each child), prior to their purchase by the PPLI. The promissory note will require interest to be paid or accrued from the installment note, however, if the investment’s rate of return exceeds the IRS’s Applicable Federal Rate in effect at the inception of the loan, the prospective benefits of this investment could have significant opportunity to outweigh the costs of setting up this structure. Accessing cash values through borrowing and loan repayments can be a viable technique, however it is also notable that if you are not likely to require the use of proceeds from a policy, your ultimate goals might best be served through strategies that provide maximum benefit to your heirs.The above, of course, would be a component of the overall structure which still needs to adhere to the various requirements including the Investor Control limitations and Diversification Requirements previously described. By using the structure of a PPLI policy, it is possible to obtain significant income and estate tax savings.

Caveats

When utilizing these strategies, one must be mindful of strictly adhering to Internal Revenue Service guidelines with respect to the Investor Control Doctrine, Diversification Requirements, and all other considerations. It is of great importance to emphasize that all investment decisions for the separate accounts must be made by an independent investment manager of which the policy holder may not be involved with. It can be noted, however, that the ability of the policy holder to suggest from broad and general strategies does not constitute exerting control over investment decisions for purposes of attributing ownership to the policy holder and voiding the tax benefits of using a PPLI contract. As with any important tax planning matters, we suggest that the policy holder secure independent opinions from their tax attorneys prior to proceeding forward with any of these structures.

Do you qualify?

The minimum requirement for participation in PPLI is being an “accredited investor” (having a net worth of at least $ 1M excluding residence and at least $ 200,000 of income in each of the two preceding years), as well as a being a “qualified purchaser” (an individual worth at least $ 5M or an entity worth $ 20M). Irrevocable Life Insurance Trusts (ILIT’s) with less than $ 5M may qualify if a bank is a trustee or co-trustee and makes investment decisions.

PPLI vs. Traditional Life Insurance: PPLI is an especially attractive option for high-net-worth individuals and families because unlike a traditional life insurance policy which generally has a higher sales load, PPLI has a significantly lower cost structure which can be enhanced by minimizing the death benefits and associated mortality charges.  Where the goals of traditional life insurance policies often seek higher death benefits and lower cash values, the goal of PPLI is typically the reverse; that is, maximizing the tax-free growth of investment accumulation and earnings accompanied by a secondary desire for the minimum required amount of death benefits. To be clear, there are many purposes and reasons to use traditional life insurance products. As an independent life insurance professional, however, I believe it is most important to deploy the right strategies for my clients and their specific goals. PPLI when designed correctly, can be an ideal tax saving investment solution framed within an insurance structure that is highly advantageous for high-net-worth families.