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Tier One: Stranger In a Strange Land (Avoid PFICs)

A common mistake for U.S. expatriates is to purchase a local life insurance policy where they are living without realizing the policy may not be considered life insurance under U.S. tax law. Worse yet, the foreign policy could be a PFIC!

The term “PFIC” stands for Passive Foreign Investment Company and is subject to punitive and complicated tax rules. U.S. expatriates should know what a PFIC is and, if possible, avoid them.

A PFIC is an investment in a company where:

  • Based on the company's income, at least 75% of the corporation's gross income is "passive." Income from investments would be passive, but not that from the company's regular business operations; or,

  • Based on the company's assets, at least 50% of the company's assets are investments which produce income in the form of earned interest, dividends or capital gains.

Investments defined as PFICs are subject to strict and extremely complicated tax guidelines by the IRS in Internal Revenue Code (“IRC”) Sections 1291 through 1297. The United States has penalized this type of investment because it cannot monitor the growth of the investment and any income generated. Examples include non-U.S. mutual funds, money market funds, insurance policies and pension plans.

PFICs and Life Insurance

How does a PFIC-designation relate to a life insurance policy? In many overseas financial jurisdiction, unit-linked products are considered life insurance contracts. These are usually investment funds, like mutual funds, which are ‘wrapped’ with a small amount of life insurance-often as low as just one percent of the value of the underlying investments (hence, the nickname “101 policies”).

These types of policies do not meet the definition of life insurance in the United States as defined in IRC §7702. Compliant U.S. policies require a significant amount of death benefit in the early years of a policy and have rules about the nature and structure of any underlying investments. When a U.S. Person purchases a unit-linked contract, the IRS will determine the taxpayer is not holding a life insurance policy but, rather, one or more PFICs and is invested in the underlying funds and subject to U.S. taxation.

This also means the U.S. Person does not receive the tax-preferential treatment of a U.S. life insurance policy such as tax-deferred growth of the cash value. Harsher still, any death benefit proceeds from the non-U.S.-compliant life insurance policy will be treated like any investment account and subject to estate tax.

U.S. Tax Reporting

Any foreign insurance policy, U.S.-tax compliant or not, is a foreign financial account which much be reported on Form 8938 to the IRS if the cash value meets certain thresholds:

  • Single: Aggregate foreign assets of USD 200,000 on the last day of the year or USD 300,000 at any time during the year.

  • Married Filing Jointly: Aggregate foreign assets of USD 400,000 on the last day of the year or USD 600,000 at any time during the year.

The U.S. taxpayer must also report the foreign life insurance policy on their FinCEN 114, the Foreign Bank and Financial Account Form (“FBAR”).

Further adding to the reporting burden, as PFICs, the U.S. expatriate has a duty to report all the funds (PFICs) held in the policy/investment on Form 8621. Any time the insurance company buys or sells funds, the taxpayer has a taxable event under excess distribution rules. At the death of the insured, the PFICs inside the policy will be considered sold and trigger additional tax, subject to excess distribution.

Case Study

Frida Johnson, an American from Chicago, is a noted biologist who has started a technology company in Amsterdam. While abroad, Frida decides to purchase life insurance and seeks the advice and services of a local producer, Scooter Hentges, who presents Frida with a number of local insurance policy options. Scooter shows Frida three unit-linked policies where Frida can invest her U.S.-equivalent of $1 million budgeted premium and only have to pay charges on a low $10,000 amount of life insurance, or 1%.

Frida is attracted by both the ability to invest in a variety of foreign funds under the policy as well as the low insurance costs. Such a low-cost structure would allow the policy cash value to grow faster over her lifetime. However, when she spoke by phone to an insurance broker back home in Chicago, Frida was told her $1 million would need to buy a minimum of $8 million in death benefit. Although this policy would have a higher, initial death benefit, the insurance costs to pay for that benefit means the cash value would not grow as fast.

Should Frida say “yes” to a policy offered by Scooter? Obviously not, as the unit-linked policy is not a compliant policy under U.S. tax rules and the investments in the policy will likely be deemed PFICs. Not only will Frida not have the life insurance coverage she sought, she will have a lot more tax reporting to perform as well as taxes to pay on the growth and disposition of the PFICs in the policy (not to mention estate taxes on the death benefit later).

Be Careful

U.S. expatriates seeking life insurance abroad need to understand what constitutes a compliant life insurance policy. If a foreign policy is purchased which does not meet the strict IRS definition of life insurance, the policy not only loses the tax benefits of life insurance, such as tax-free cash value growth, the ability to take tax-free policy loans and, possibly, the income-tax-free death benefit, but the policy investments could be considered PFICs. These expatriates should consult a tax professional knowledgeable about expatriate issues before making a decision about buying a foreign life insurance policy.

Read our companion Tier One Interview with Christiana Lazo by clicking here.

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

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