For wealthy investors it is really about what they keep, not necessarily how much they earn. A great performing investment can become very mediocre once taxes are taken into account. While some investment professionals might produce above average returns, their investment strategy may be very tax-inefficient resulting in less than stellar returns to their investors. Even when the investment strategies are relatively tax-efficient, over time, taxes can be a drag on performance. 

Private Placement Life Insurance
“Private placement life insurance—often referred to by its initials: PPLI—is a version of variable universal life insurance that has been designed for the high-net-worth market,” says Jeb Burton, the Managing Principal of The Burton Law Firm. “A PPLI policy is, basically, composed of two components. An insurance component that is typically designed to deliver the lowest amount of insurance protection to qualify the policy as ‘life insurance’ to achieve the desired tax benefits. With PPLI, insurance fees and costs are minimized resulting in economies of scale in issuing a policy with a very high premium. There’s also an investment component, which is similar to any other investment fund, except that, because it’s owned through a life insurance policy, there is generally no income tax charge to the policyholder while asset values in the account increase. Another critical consideration that can be easily overlooked is embedded capital gains.”

According to Frank Seneco, president of the advanced life instance planning boutique, Seneco & Associates, “What regularly makes PPLI additionally attractive and extremely appealing to wealthy families is the investment options can be tailored to meet their needs and wants. In other words, their single-family office can often manage the monies within a PPLI policy. Meanwhile, the cost of insurance per dollar of coverage is much reduced compared to traditional life insurance resulting in overall lower costs.”

Income Tax Benefits
Profits generated by investments inside the PPLI policy grow tax-deferred. No income tax is due on growth in the policy investment account unless earnings are withdrawn from the policy. A policy owner can withdraw cash from the policy at any time up to the amount of premiums paid without having to pay any taxes. Withdrawals in excess of this amount are taxable as ordinary income. Instead of paying taxes at this time, a policy owner can also borrow against the policy tax free provided the policy was set up to enable this to happen. 

“Depending on the terms of the policy, the insurance company may allow a policy owner to borrow up to a certain percentage of the cash surrender value of the policy—including amounts in excess of the aggregate premiums paid,” says Anthony Glomski, President of AG Asset Advisory Family Office. “The loan, which bears interest, must be repaid on death of the insured or lapse or surrender of the policy, so it’s important that the policy be maintained until death if large amounts have been borrowed against the policy.”

Proceeds payable at the insured’s death are generally received free of income tax. Additional planning can be implemented so that the PPLI policy death benefits pass free from estate tax and inheritance taxes. 

Uses Of PPLI By Single-Family Offices
PPLI can accomplish several goals that are potentially of interest to wealthy families and their single-family offices. These include:

• Negating the adverse impact of taxes on tax-inefficient assets: By putting tax-inefficient assets such as many hedge funds in a PPLI policy, short-term capital gains that would otherwise be taxed as ordinary income are avoided. 

• The ability to invest in alternative or esoteric assets: Based on the jurisdiction, certain alternative assets such as foreign mutual funds for US citizens and private companies for investors with specific residencies can be the investment vehicles within a PPLI policy. 

• Enhancing certain estate planning techniques: “Many effective estate tax mitigation techniques require the current wealth holders pay tax on any income or gains generated from the assets that were sold or gifted away,” says Arron Yen, senior partner, Ascendent Law Group. “For instance, by having a trust use assets to fund the purchase of a PPLI policy, there will not be any realized income or gains on the growth of those assets.”

• Funding for deferred compensation for single-family office senior executives: “PPLI is being used as a way to better enable senior executives to participate in the success of the single-family offices without sharing equity or providing unencumbered performance compensation,” says Cliff Oberlin, Chairman and CEO of Oberlin Wealth Partners.

Why PPLI will Become More Pervasive
The amount of money in PPLI policies as well as the number of PPLI policies is likely going to increase substantially in the coming years. There are basically four reasons for what will probably be a tremendous increase in assets:

• The significant increase in the number wealthy families and their levels of wealth: Generally speaking, extreme personal wealth is becoming increasingly greater and more concentrated. 

• The desire of wealthy families the world over to legally mitigate taxes: Very, very few people are inclined to pay any more in taxes than they are absolutely required to pay. Consequently, wealthy families are usually motivated to identify and use all the perfectly legal ways to lower their tax bills. 

• More sophisticated single-family offices: The increasing number of single-family offices, coupled with more “demanding” wealthy families, is resulting in increasing professionalism among single-family offices. 

• Increasing versatility and ease of use of PPLI: According to Seneco, “PPLI is now more available and applicable to a wider range of wealthy investors than ever before. What’s also likely to happen is that a growing number of erudite wealth managers and legal professionals are becoming knowledgeable and adept when it comes to PPLI, and they are bringing this solution to their wealthy clients.”

So long as there are taxes on investments, PPLI under the right circumstances will be a very powerful solution for many wealthy families. While PPLI is a very effective way to mitigate certain taxes, it’s essential to remember that PPLI is life insurance first and foremost.

A growing number of single-family office senior executives and their advisors are recognizing the possibilities and uses of PPLI. Moreover, PPLI is increasingly and creatively being used as part of the compensation arrangements for senior management of single-family offices. Consequently, all indications point to PPLI becoming a more meaningful part of the investment and life insurance portfolios of wealthy families.

For a complimentary PDF copy of Maximizing Your Single-Family Office: Leveraging the Power of Outsourcing and Stress Testing request the book from [email protected].