Hungry For Returns
The new tax regime is only part of the reason for increased demand. With stocks at frothy levels and 10-year Treasury yields refusing to stay above 3 percent, investors are having to search further afield for returns.
Bernstein Private Wealth Management last year created diversified portfolios designed for use in PPLIs, which include hedge funds, middle-market lending, securitized mortgage funds, and stocks and bonds. The tricky part with these investments is that they’re frequently taxed as ordinary income with marginal rates that approach 50 percent in high-tax U.S. states. Inside a PPLI, they aren’t taxed at all.
“There’s demand and we’re trying to fill that demand,” said Thomas Pauloski, national managing director of wealth strategies at Bernstein. “People who are hungry for 10 percent returns are going to have to look in very specialized places.”
While there aren’t really any limits on what kind of investments can be put in a PPLI, there are strict rules managers have to follow to avoid Internal Revenue Service scrutiny. Investors must surrender control to a manager and can’t interfere in his or her decisions. The holdings in a PPLI must also be properly diversified, which is what requires hedge fund managers to set up special insurance dedicated funds to be included.
With the increased popularity, life insurers have slashed the fees they charge for wealthy clients. A typical cost is now as low as 0.7 percent per year, cut by more than half since the early 2000s, Pauloski said.
The structures effectively lock up your assets, an inconvenient option if you need ready access to your fortune. But there’s still a way to tap the money while alive. You can take loans against the investment’s cash value, tax free.
It’s a "historical accident" that Americans aren’t required to pay taxes on assets placed in life insurance contracts, said Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center. The Treasury estimated in October that it will lose about $166 billion over the next decade by not taxing insured death benefits. If the cost climbs due to PPLIs, "it could become an item of attention for Congress," Rosenthal said.
That moment may be approaching. “When I would talk about it years ago, people looked at you funny,” said Edward Gordon, founder of Preservation Capital Partners. Lawyers for the wealthy hadn’t heard of PPLIs and often dissuaded their clients from trying a product that “sounded too good to be true,” he said. Now, “it’s reaching somewhat of a tipping point.”
This article was provided by Bloomberg News.