Tier One: I’m Now Seeing the Impact of the Changes to IRC §7702
For a recap on the changes to the interest rate assumptions supporting IRC §7702 made by the Consolidated Appropriations Act 2021, check out our March article on the subject. In the first month after the Act was passed, I participated in an endless number of Zoom calls with life insurance company product and actuarial executives who said it would be some months to a year or more before the §7702 changes could be made to their retail products. After all the internal pricing work is complete, the retooled products would need to be filed with each life insurance department and, in total, would take a while.
Where the changes were implemented with lightning speed was with private placement life insurance companies, especially those offshore carriers which made a §953(d) election to be treated as a U.S. taxpayer in Bermuda, Cayman or Puerto Rico. Regulators in these offshore jurisdictions usually move a lot faster than the insurance departments in the U.S.
However, the changes to U.S. PPLI insurers quickly followed since most U.S. PPLI carrier are only domiciled in the few states where state premium taxes are low, like Delaware and South Dakota. It isn’t nearly as soul-crushing to deal with one or two state insurance departments as it is to interact with dozens and, of course, the State of New York.
Not only have PPLI carriers been illustrating using the new §7702 rates but, due to Biden’s proposed tax increases in the American Families Plan introduced on April 28, PPLI activity has skyrocketed giving me a chance to review plenty of proposals. What I have seen has blown my mind and filled me with glee – I saw a single premium non-MEC!
No, that wasn’t a typo and, honestly, when I saw my first single premium non-MEC, I thought it was an error. It couldn’t possibly be true. I emailed and called experts, had the illustration re-run and then called and emailed more people to confirm. “Yes, Virginia, there is a Santa Claus” and he will allow some policyholders to fund their PPLI policies all at once and be able to preserve the ability to access the policy down the road for withdrawals and tax-free loans.
Now that America has opened up, I’ve booked several speaking spots all over the country. One of the topics in my portfolio is “Getting Reacquainted with PPLI in an Increasingly Taxed World.” Here, I demonstrate the power of using PPLI and PPVA under which to make an investment that would otherwise be highly taxed. As an example, I show a 50-year-old making a $10 million investment into a hedge fund and seeing what it looks like after 20 years. Then, I compare the same investment as if it were done through a PPLI policy and a PPVA. For the results, catch my live show in Las Vegas (true) or another one of my speaking engagements.
For the purposes of this article, what is important is what was sent to me for the PPLI illustrations for a 50-year-old, non-smoker, preferred male for a $10 million premium at a 9.65% return (hedge fund return at 12% less fees). I asked for the cursory MEC so I could talk about how, with PPLI, you usually buy a MEC when you are not intending to access the policy and you are likely to die holding it. By the way, this strategy gets you a step-up in basis at death for the investments in the policy and is now, incredibly powerful, thanks to the President’s proposal to remove the step-up in basis.
Although clients purchasing PPLI often talk about needing a non-MEC in order to preserve access, very few PPLI contracts are ever touched for any kind of distribution. This follows my belief when it comes to selling life insurance that the wealthier the client is, the more they think they might run out of money and need to tap the policy.
Besides a MEC, I asked to see non-MEC short pays. Since PPLI is institutionally priced, prior to the §7702 changes, you might be lucky to see a 3-pay non-MEC. Granted, this did not allow a policyholder to fund all at once but, if the policy were to be backdated, the policyholder could pay two premiums right away in two consecutive banking days and then pay the third premium a year later. Not ideal, but it was the best that could be done and problematic for foreign grantor trusts with U.S. beneficiaries where funding a policy all at once cuts off Undistributed Net Income (UNI) because there isn’t any money left outside the policy to be taxed.
I spotted the 3-pay non-MEC in my requested illustrations and then, with a smile on my face, saw the 2-pay. This was expected with the new rules, but it is always nice to see. If an insurance company permits backdating, a 2-pay makes it fairly easy to properly fund a non-MEC since you can make the payments two days in a row in exchange for paying for a year’s cost of insurance. Not ideal, but a good way to get the policyholder all set with their policy.
What I didn’t expect to see in my illustration file was a tab labeled “non-MEC lump sum”. There it was, the Holy Grail of PPLI life insurance illustrations. A single premium of $10 million purchasing a net amount at risk of nearly $121 million! It appeared that CVAT, and not GPT, was the test applied and that probably helped.
Full disclosure – the illustrations came from Prudential which has its pros and a few cons when it comes to PPLI. On the plus side, they are extremely low cost and have a lot of retention as well as reinsurance agreements which will permit the over $120 million net amount of risk in the non-MEC lump sum. Most PPLI carriers retain little risk and farm out all but $50,000 to $250,000 in risk to the big reinsurers and this generally limits their net amount at risk to no more than $70 million or so.
On the minus side, Prudential has traditionally been what is called a ‘platform player’ in PPLI. Unlike Advantage Life, Crown Global and Lombard who will on-board a client’s IDF (insurance dedicated fund) or SMA (separately managed account), Prudential requires policyholders to choose from their platform of IDFs and SMAs much like choosing from a 401(k) list. That’s okay if the policyholder has their eye on a specific investment but, if you’re a family office who would love to recreate the investment portfolio already being applied under a PPLI policy or PPVA, you’re out of luck. That said, Prudential has made recent progress by permitting clients to add their own customized SMAs if the money manager and premium amount meet required minimums. This is a big improvement for Prudential and welcome to see.
Not all the major PPLI carriers have made changes to comply with the new §7702 rules, yet, so it remains to be seen which of them will be able to issue single-premium non-MEC contracts. I am hopeful for the industry and prospective client that we will see many more!
Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.