As we spring forward into 2021, ascending from the darkness of COVID-19, traditional thinking has been challenged as we reflect on the importance of life, health, family and finances. Our shared pandemic experiences have provided us the opportunity to abandon antiquated beliefs and enter a fresh new era of thoughtful and modernized estate, business and asset protection planning. Today, we educate, problem-solve and delay no further as we enter the enhanced age of properly constructed private placement life insurance (PPLI) for ultra-high-net-worth individuals and families.
In summary, PPLI provides the ability to allocate to alternative investments, traditional long-only managers and low-cost beta strategies, in a tax-efficient manner while creating efficiencies not found in other traditional life insurance solutions.
Currently, there is a powerful confluence of critical factors that make thoughtful estate planning and the use of PPLI particularly attractive and time sensitive:
- Lifetime exemption levels at all-time highs ($11.7 million per individual/$23.4 million per couple);
- April 2021 mid-term applicable federal rate (AFR) is 0.89%;
- Top marginal federal estate tax rate is 40% with a potential proposed increase;
- Top marginal federal income tax rate is 37% with a potential proposed increase;
- The effective elimination of state and local tax (SALT) deductions for UHNW families; and
- 200-plus alternative investment strategies available through PPLI.
For comparison, in 1996, an individual’s lifetime exemption was $600,000 and the January mid-term AFR rate was 5.73%. The top marginal federal estate tax rate was 55%, and the top marginal federal income tax rate was 39.6%. Note: PPLI was in its infancy with limited insurance dedicated funds (IDFs) available.
There is also speculation that the estate tax exemption will decrease and that estate and income tax rates will increase. With these potential changes in mind, and even if the current tax environment remains, understanding the benefits that PPLI can add to a family’s income and wealth transfer planning is important.
Properly constructed PPLI creates a compelling investment and legacy planning opportunity:
- Accumulated investment income earned under a life insurance contract is not subject to current period taxation. Policy account values may be transferred among investment strategies within the policy without triggering tax recognition. This is particularly attractive when allocating among tax-inefficient alternative investments with high turnover. [IRC 7702 (g)(1)(A)];
- Assuming the policy is structured as a non-modified endowment contract (non-MEC), supplemental income can be distributed from PPLI using first in first out (FIFO) accounting whereby the distribution of basis is taken without recognition of income tax. Additionally, policy loans of up to approximately 85% of the PPLI cash value can be distributed at a minimal cost income-tax-free. [IRC 72 (e)(5)];
- Insurance benefits received from a life insurance contract, including any accumulated investment income, are generally received income-tax-free. [IRC 101 (a)(1)]; and
- If properly arranged, the proceeds of a life insurance policy paid to an irrevocable trust will be excluded from the taxable estate of the insured. With lifetime exemption levels at all-time highs and the mid-term AFR at sub 1%, now is the time to gift or loan money to an irrevocable trust.
Given the fact the Federal Reserve has been reducing interest rates since the early 2000s, traditional life insurance product lines (Whole Life, Universal Life, Indexed Universal Life, etc.) have been adversely affected and should be reviewed. All major life insurance companies have been affected by the Federal Reserve’s interest rate reduction policy, resulting in suppressed life insurance policy dividend and/or interest crediting rates. The lower the crediting rate, the less cash value growth within the policy, which often leads to increased premium obligations. Many consumers of traditional life insurance products are not aware of the correlation between interest rates, policy charges and long-term policy performance.
PPLI combines the protection and tax advantages of life insurance with a robust investment platform on which to allocate. Policy owners can allocate (and reallocate) to comingled or customized investment options made available by the insurance company. The array of available investment options has grown significantly in recent years. PPLI pricing is fully transparent with fees and charges that are lower than traditional products. PPLI policies are typically designed to minimize policy charges in order to maximize long-term account value and insurance benefit growth. The annualized “cost” of PPLI averages roughly 50–70 basis points over the lifetime of the insured and can prove quite compelling especially when entering an increasing-tax-rate environment. That said, PPLI should be viewed as a long-term investment that may not be suitable for all families.
As we recalibrate and contemplate planning opportunities in the current political environment, we think it is prudent to evaluate PPLI as a potential component of wealth transfer planning. Properly constructed and administered PPLI can be advantageous to ultra-high-net-worth individuals and families, allowing for tax-efficient savings and wealth transfer opportunities for those willing to become educated on the subject and take action.
Brady C. Knight and Chelsea Maeda are principals at Winged Keel Group.
Winged Keel Group is independently owned and operated. Securities offered through M Holdings Securities, Inc., a Registered Broker/Dealer, Member FINRA/SIPC. The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and are provided with the understanding that Winged Keel Group is not engaged in rendering tax or legal services. A Private Placement Life Insurance (PPLI) Account is an unregistered securities product and is not subject to the same regulatory requirements as registered products. As such, a PPLI Account should only be presented to accredited investors or qualified purchasers as described by the Securities Act of 1933. The value of the investment options will fluctuate and, when redeemed, may be worth more or less than the original cost. Withdrawals and other distributions of taxable amounts, including insurance benefit payments, will be subject to ordinary income tax. If withdrawals and other distributions are taken prior to age 59 1/2 a 10% federal penalty may apply. A withdrawal charge may also apply. Withdrawals will reduce the value of the insurance benefit and any optional benefits. #3553570.1
