Thanks to the tremendous response we received regarding Frank’s “Hampton Freeze” Mountain Vision update last week, we wanted to help our readers explore the depths of PPLI more. You were clearly interested in deferring or eliminating income tax, internationally diversifying your wealth, and looking outside the box for protecting your wealth.
From companies, trusts, and foundations to partnerships and insurance policies, there is a broad range of financial vehicles employed in estate planning to preserve and protect wealth, with the intent to eventually be transferred to the next generation. Where US beneficiaries are concerned, life insurance policies should be a key component of that plan, especially when it comes to diversifying wealth jurisdictionally.
If you are considering protecting and growing part of your wealth offshore, you are well advised to consider the opportunities offered by an international Private Placement Life Insurance policy (PPLI) or a Private Placement Variable Annuity (PPVA) – hereafter, collectively referred to as ‘PPLI’.
Now, it’s important to not be turned off by the words ‘insurance’ or ‘annuity’. We understand that aggressive insurance agents and even some insurance companies in the US have helped to draw critical light on these solutions. But PPLI is not to be confused with any retail type of insurance or annuity policy. PPLI is a different class of solutions altogether which is not usually known, or even recommended, by the average insurance advisor.
Ultimately, what you seek is a plan that not only considers investments, but one that also addresses and properly incorporates objectives such as jurisdictional and institutional safety, asset protection and tax efficiency in achieving optimal results. Since its emergence in the mid-1990s, international PPLI has offered a more flexible and cost effective approach to traditional domestic insurance policies long associated with high broker commissions, administrative costs and investment fees.
As we will elaborate more on in this article, PPLI also offers several advantages in comparison to other forms of wealth planning such as a trust.
PPLIs offer higher potential returns
Contrary to the standard retail type of life insurance products you may be familiar with, international PPLI offers considerably more investment flexibility. As an example, while traditional policies require a client to use the insurance carrier’s limited array of investment strategies and funds, a PPLI policy allows you to not only define a personalized investment strategy, but you can select the investment advisor to manage that investment strategy within the policy as well. As a result, you enjoy a much broader choice of investments with the potential for higher returns.
Additionally, PPLI policies purchased from a non-US carrier provide the opportunity to mandate investment managers from other regions of the world, and to safe-keep the assets held within the policy with international banks of your preference.
This level of personalized tailoring and flexibility is typically not available in the US. Needless to say, benefits extend to institutional pricing with full cost transparency and tax efficiency, which will be explained in more detail later on.
The KISS Principle
Just as it equates to other areas of life, keeping things simple, as much as possible, also applies to offshore wealth planning.
Many spend hefty amounts of time and money to structure THE solution for their long-term wealth preservation plan. That will include maximized tax efficiency, sufficient investment flexibility, attractive returns, personalized estate provisions and — while we’re at it — solid asset protection. With these benefits in mind, complex legal structures are set up and a lot of money is spent on legal fees. Surely, some of the complexity is justified and valuable. However, from our experience, many investors looking for an offshore plan could do so with much more simple solutions.
Contrary to more complex offshore trust and corporate structures, PPLI combines the benefits of tax efficiency, asset protection and global investment flexibility in one. Moreover, the reporting of a PPLI policy involves the annual reporting of the value of that policy on two forms: the FBAR and the 8938 form. No complicated accounting for the reporting of realized and unrealized, long-term vs. short-term gains, no K1 reporting, etc. is required.
In the U.S., life insurance has long offered opportunities for tax-free investment growth. In its most traditional sense, insurance companies invest the premiums that policyholders pay and credit interest to the policyholders based on the insurance company’s investment results. Policyholders are not taxed on the growth of the cash values held within their policies, and their beneficiaries receive tax-free death benefits.
In addition, policyholders may access funds within those policies through loans and withdrawals usually without immediate tax consequences.
While the tax consequences of investing through traditional life insurance have always been attractive, the returns on those investments have not. The reason for these unattractive returns is due to the insurance companies being primarily concerned with protecting investment values to ensure the ability to pay claims. Therefore, the companies’ investment choices end up being too conservative for many.
Variable policies were the life insurance industry’s answer to these concerns. By segregating the investment of variable insurance policies from their general investment portfolio and transferring all the investment risk to the policyholder, insurance companies are able to offer policyholders a wider variety of investment options, while retaining the same tax benefits.
Foreign PPLI policies take it a step further. They encompass the aforementioned benefits while offering a broader array of investment options and stronger asset protection, while being subject to much lower up-front costs. For instance, contrary to domestic products, they are not subject to state premium taxes. Most US states charge a premium tax ranging from 2.5% to 3.5% of the premium paid.
Lower premiums translate into higher returns for policyholders
Offshore PPLI planning has already been around for some 15 to 20 years, but was only accessible to very wealthy families in America. The minimum premiums were substantial and therefore didn’t make sense for assets below $10 million. Today, PPLI is much more affordable and can be structured for amounts starting from $1 million!
What does the IRS have to say?
The IRS has established strict rules that apply to life insurance policies, and additional rules that apply to PPLI policies. Failure to adhere to these rules will negate the potential tax benefits of the policy, so it is absolutely critical that the PPLI structure is properly established and an on-going monitoring process is in place. The two major IRS rules relate to diversification and investor control:
Diversification: IRS Code Section 817 spells out the details and minimum diversification requirements that apply to PPLI investments. Essentially, and to give a broad idea, there must be at least five investments, with no single investment forming more than 55% of the assets held within the policy, no two investments forming more than 70%, no three investments forming more than 80%, and no four investments forming more than 90% of the fund.
Investor control: For a PPLI insurance contract to qualify for tax deferral or exemption, the assets held in the underlying investment account must be considered to be owned by the insurance company and not by the policyholder or related persons. In the scenario discussed, that means the trustee, the settlor, and the beneficiaries cannot direct the investment manager or the investment decisions for the funds.
However, they can specify and either directly, or via their trustee, if applicable, instruct the insurance carrier to implement a certain strategy, with the custodian of their choice, and with the investment manager of their preference, subject to the approval of the insurance company.
Given these issues, one frequently employed route is to use insurance dedicated funds (IDFs) which are established for the exclusive use of variable contracts issued by insurance companies and are not available to the general public. So as to ensure the benefits of PPLI are realized, the diversification rules are tightly managed in the IDFs and the management of the funds is “fire-walled”.
Qualified asset managers and advisors are familiar with these rules and have established tools and procedures to ensure that their investment strategies and services are in line with the legal requirements.
PPLI within a robust trust structure is an excellent option for US high net-worth individuals interested in jurisdictional diversification, asset protection and tax efficiency. Families seeking to establish an effective and internationalized estate plan, as well as to protect, preserve, grow and transfer family wealth should consider how PPLIs can benefit them in their particular circumstances.
However, given the size of the investment required to establish a private placement policy, and the variety of issues involved in selecting the right product and company, it is imperative to discuss the overall ramifications with a trusted, knowledgeable and competent adviser.
Is PPLI right for you? You will never know unless you learn more. Click here to request more information about PPLI.