It’s said nothing in life is certain save death and taxes. There is also certainly an increase in investors’ appetites for nontraditional instruments like hedge funds as their wealth grows. To help account for these varied “certainties” as part of an overall wealth plan, there are private placement life insurance (PPLI) and private placement variable annuities (PPVA).
The traditional versions of these vehicles, particularly insurance, begin with the end in mind. “Maximizing the death benefit is typically the ultimate objective of a life insurance policy,” says Brittany Crenshaw, a director at Raymond James whose work centers on implementing complex investment solutions for the firm’s private wealth clients. “But with private placement insurance, investors are focused on tax-deferred investment growth, and the ability to access a wider range of nontraditional investment options in a more tax-advantaged manner. The goal here is accumulation, while keeping the death benefit relatively low in order to reduce the cost of insurance.”
The primary benefit is the opportunity for compounding, tax-deferred growth, which Brittany says can be a powerful option for business owners and entrepreneurs anticipating a sale or liquidity event, for families seeking flexible estate and wealth transfer tools, or for individuals who want asset and creditor protection, such as those in careers where litigation risk is high.
If you’re in a similar situation or expect to be, here’s a deeper look at these solutions and how they might work for you.
Taxes and access
In both PPLI and PPVA solutions, the premiums paid into a policy are invested in an underlying portfolio which is managed by a third party – typically the owner’s financial advisor. While held inside the policy, investments grow tax-deferred, creating a powerful opportunity for compound growth on all gains.
As mentioned, the tax benefit is the primary driver for most PPLI and PPVA purchasers, but it’s far from the only one. Private placement products also offer investors enhanced access to more complex financial instruments. Standard insurance and variable annuity policies tend to offer a more limited and more traditional pool of investment options, but with private placement, policyholders can choose from a more sophisticated mix, including hedge funds, real estate and private equity.
Another potential benefit in the case of PPLIs is preservation. Depending on the state, the structure of these solutions may offer a layer of protection and privacy to the underlying assets via the insurance wrapper. As mentioned, this makes it a compelling option for clients whose careers open them up to litigation risk – doctors, attorneys, real estate agents, even chefs.
Keep in mind that the array of potential benefits are accompanied by their own sets of rules. Due to the tax advantages, the IRS applies a legal concept called the investor control doctrine to PPLIs and PPVAs. This requires that policyholders have no direct participation in the investment selection process for the underlying portfolios. If the doctrine is violated, a policyholder may be deemed the asset owner and held responsible for any taxes assessed.
Additionally, for PPVAs, while investments grow tax-free, gains are paid once funds are withdrawn or accessed from the policy. Withdrawals are treated as ordinary income and may be subject to a 10% early withdrawal penalty if taken prior to age 59 ½.
Finally, investors in these policies must qualify as purchasers. This includes meeting certain purchaser standards and net-worth minimums and being familiar with the more sophisticated investment alternatives at play. In Brittany’s experience, “These are not the traditional insurance or annuity purchasers. These are ultra-high-net-worth clients who generally already have their insurance and long-term liquidity needs covered.”
PPLI vs. PPVA
While the ultimate goals and funding requirements are similar, there are some fundamental differences between PPLI and PPVA solutions to keep in mind if you find yourself choosing between them.
Namely, a PPLI is an insurance product, a PPVA is an annuity, and both are structured accordingly.
PPLIs follow the typical insurance process and require medical assessments for underwriting. PPVA options, like other annuities, don’t require medical evaluation, which can make them a better option for investors with pre-existing health concerns or conditions.
Timing may be another mark in the win column for PPVA products, as issuance averages two weeks for new cash purchases versus the six-week wait associated with PPLIs.
Cost, too, can be an advantage for PPVAs, as the insurance benefit of PPLI products involves an additional cost of insurance charge.
In the end
Where PPLIs get their signature edge over PPVAs is in how they’re ultimately transferred to beneficiaries.
As an insurance product, a PPLI has a death benefit that is passed to its beneficiary tax free. What’s more, the beneficiary receives the death benefit or the cash value of the PPLI’s underlying portfolio, whichever is greater. This is where the performance of the investments and potentially years of compounding, tax-deferred growth can be a gamechanger in building an even more impactful financial legacy.
On the other hand, a PPVA is treated as ordinary income when it transfers to a beneficiary. However, in cases where a PPVA is left to a qualified charitable organization, the funds aren’t taxed, making it something to keep in mind as a philanthropic vehicle.
Whatever the individual goals and whichever product is most suited to them, Brittany encourages investors to keep their risk tolerance and time horizons in mind. “Because the tax advantages for wealth accumulation and estate planning are the primary focus of these solutions, they’re going to be most powerful for sophisticated investors with their other financial bases covered and time on their side.”
Alternative investments involve specific risks that may be greater than those associated with traditional investments and may be offered only to clients who meet specific suitability requirements, including minimum net worth tests. You should consider the special risks with alternative investments including limited liquidity, tax considerations, incentive fee structures, potentially speculative investment strategies, and different regulatory and reporting requirements. You should only invest in hedge funds, or other similar strategies, if you do not require a liquid investment and can bear the risk of substantial losses. There can be no assurance that any investment will meet its performance objectives or that substantial losses will be avoided.
Raymond James does not provide tax or legal advice. Please discuss these matters with the appropriate professional. Diversification does not guarantee a profit nor protect against loss.
Insurance products offered through Raymond James Insurance Group, Inc., an affiliate of Raymond James & Associates, Inc. and Raymond James Financial Services, Inc
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