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  • Writer's pictureJay Judas

Tier One: Family Offices Turn to PPLI to Eliminate Taxation on Investments

An attribute of private placement life insurance (PPLI) is that the policy generally needs to be held for the long-term – at least 10 years if not 15 or more – to fully realize the tax benefits of the strategy. As a refresher, PPLI is less of a life insurance transaction and more of an investment solution. By investing into highly tax-inefficient asset classes under a life insurance structure, a policyholder is able to obtain the tax benefits of life insurance. These benefits include tax-deferred growth, tax-free access to distributions and the ability to convert the investments into an income tax-free death benefit. It is this last feature to which family offices are increasingly turning in carrying out generational wealth transfer strategies.

For more on PPLI, check out this earlier post to bring yourself up to speed.

Before discussing the growing popularity of PPLI with family offices, it is important to understand one of the structural reasons why PPLI is having a renaissance, in general. This is due to the change two years ago to the Internal Revenue Code’s definition of life insurance as defined in §7702. This change permitted the ability to pay considerably more premium into a cash value life insurance policy for the same amount of death benefit expense – sometimes more than two times as much. For more on this change, read here and then here.

Are You Really Going to Touch Those Investments?

For many qualified purchasers and accredited investors who use PPLI, preserving the ability to someday be able to take distributions from the policy in the form of income tax-free withdrawals and loans is important. Interestingly, I can count on two hands the number of times I have seen a PPLI policy accessed for liquidity over the past 16 years. It just doesn’t happen, and this is likely due to the wealth profile of the common user of a PPLI solution.

Still, by structuring a PPLI policy as a non-modified endowment contract (non-MEC), the policyholder will someday, if needed, be entitled to income tax-free loans which remain tax-free as long as the policy remains in-force for the life of the insured. This contingency comes with a price – additional life insurance expense - than if the policy had been structured as a modified endowment contract (MEC). But what if the policyholder knew that the policy would never be accessed and their policy could be structured as a MEC, lowering policy costs?

For family offices who regularly invest for generational wealth transfer where designated capital is earmarked to be passed on to several generations, the goal fits well with the buy-and-hold nature of PPLI. In exchange for paying policy expenses, all investments made under a PPLI policy can pass to a beneficiary without ever having to pay any investment income tax. Here is an example how this might be structured:

A family office has set aside $100 million in trust to be passed to generations 2 (G2) and generation 3 (G3). That amount can be in cash or available to be converted to cash in the short-term. G2 and G3 are made up of 15 individuals who vary in age from 23 to 58. The family office is able to ‘spreadsheet’ the members of G2 and G3 to decide how much premium to allocate to the PPLI policies placed on each of their lives, taking into account the insurance costs attributable to each based upon gender, health and age. For instance, a 23-year-old female may be in top health and have low insurance costs but they would also quickly ‘eat up’ the death benefit capacity available.

Conversely, a 58-year-old male might have some health concerns and higher insurance costs but able to absorb more premium before capacity becomes an issue. For the family office, allocating investment, or premium dollars, becomes a bit of a math problem. The younger G3 female might have $4 million in premium allocated to her policy while the 58-year-old member of G2 might have $15 million. These premiums can be in a single premium (forming a MEC) or made in multiple premiums as liquidity becomes available (forming either a MEC or non-MEC).

In this example, all the policies are trust-owned and the beneficiary for the income tax-free death benefits are either the same trust or another family trust. The amount of inheritance each heir will be receiving has little to do with the PPLI strategy since this strategy is centered upon moving investment wealth from one generation to the next without taxation and with as little cost as possible. The lives of the insureds are essentially the tools for carrying out the wealth transfer.

There is also a death benefit timing component to this strategy. The greater the number of family members and insureds, the more accurate a family office can be in timing the receipt of death benefits. Some PPLI carriers permit the part of the death benefit consisting of a policy’s cash value to be paid in-kind, meaning that the investments within the policy do not have to be liquidated (avoiding an ill-timed sale) and can be paid-out income tax-free in their invested form.

What Kind of Investments?

The rules around permissible PPLI investments continue to apply. Cash paid into a policy can either be invested in a separately managed account (SMA) by a discretionary manager or into an insurance dedicated fund (IDF) that has its own manager. A family office should take care on how their office is structured to avoid violating the §817(h) Investor Control Doctrine that prohibits the policyowner and insured from making a policy’s investment decisions. In accommodating this, many families establish at least one family office LLC where the family has LP interest, and the family office CEO or other officer has the GP interest and can make PPLI policy investment decisions without violating the Doctrine.

Never Pay Taxes Again

When deploying a trust-owned investment strategy that is aimed at holding investments for as long as a trust will permit before distribution, why pay taxes on those investments? By studying their investment portfolio and taking into account the number and make-up of existing future generation members, a family office can make the most tax-inefficient investments under one or more PPLI policies and eliminate tax leakage for decades to come.


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