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A Special Kind of Life Insurance for Disappointed Hedge-Fund Clients

Private placement life insurance, which is as much about asset protection as it is about growing assets, offers HNW client tax-advantaged hedge-fund investing and other benefits.

December 18, 2008
by Lewis Schiff

Do you have a client who's had a dissapointing hedge fund experience? They're not hard to find — throw a rock in any direction in a high-net-worth (HNW) neighborhood and you're likely to hit one. With the value of alternative assets depressed, perhaps it's the right time to introduce these clients to "Private Placement Life Insurance." This offers tax-advantaged investing and asset protection all rolled up into one.

One of the benefits of working with advanced planning networks is they can add the right kind of specialist to deliver a better solution for the client than an advisor might be able to achieve working on their own. One example of an advanced planning solution that requires unique expertise is Private Placement Life Insurance — a powerful solution that's also powerfully intricate.

Private Placement Life Insurance (PPLI) resembles a typical variable policy the way a custom-made dress shirt resembles the offerings at J.C. Penny. Both have their purposes — they're just engineered to different standards with different applications. PPLI can be used to fine-tune an investment portfolio for a HNW client. When it is, PPLI must be tailored to the client's circumstances. Not surprisingly, PPLI is more complex and time-consuming to set up.

History

PPLI first began to emerge around 1996. At that time, several small companies offered the product. A few years later, mainstream players such as New York Life, AIG, Sun Life, Prudential, and Mass Mutual had joined in and the solution's appeal grew. At the same time, the use of PPLI expanded from seeking investment growth free of federal income tax in a cash-value account to designing sophisticated estate planning solutions to mitigate estate taxes on the transfer of wealth using the death benefit. Now, PPLI solutions support wealth transfer, wealth creation, and philanthropic needs, by using the death benefit in tax-advantaged ways.

Not surprisingly, some of the most eager adopters for PPLI have been those with hedge-fund experience who wanted to improve their tax edge. For one New York advisor with such a clientele, they typically have a net worth of $15 million to a couple of hundred million with a goal of increasing their net-worth on the tax-free policy investments.

For several years, Robert W. Chesner, Jr., an attorney with Austin, Texas-based Giordani Schurig Beckett Tackett LLP,  has used PPLI with a variety of affluent clients. If a client with a net worth of $100 million comes to the firm, they will likely already have done some hedge fund or other alternative investing, he notes. Those investments are subject to ordinary income tax — federal, state and municipal — however. A client residing in California or New York City, for example, would see their investment income subject to more than 45 percent in income taxes. When a nine-percent return-nets more like five percent after taxes, the investment starts resembling a muni. For this kind of client and even those residing in states without a state income tax, investing in the same or similar portfolio within a PPLI offers a major advantage by eliminating the federal income tax portion (35% for high-income clients).

Tax-Free Growth

Leslie C. Giordani and Michael H. Ripp, Jr., also attorneys with Giordani Schurig Beckett Tackett LLP, Austin, TX, have demonstrated the advantages of accumulating returns inside a PPLI versus a taxed investment (Private Placement Life Insurance Planning (Part 1), ALI-ABA Estate

End of Year Taxed Investment Life Insurance Cash Value Life Insurance Death Benefit
1 2,650,000 2,664,490 43,900,480
5 12,288,296 13,350,680 43,900,480
10 16,444,512 20,508,070 43,900,480
20 29,449,617 50,071,060 61,086,690
30 52,739,779 125,094,550 133,851,180
40 94,448,912 312,914,460 328,560,160

Planning Course Materials Journal, 2006). In their hypothetical example, they show the side-by-side scenarios for a PPLI policy insuring a 45-year-old man with a $2.5 million annual premium for five years and a 10 percent rate of return net of investment-management fees (taxed as ordinary income.) A hypothetical combined federal and state rate of 40 percent was used (see table).

Asset Growth: Taxed Investment vs. Private Placement Life Insurance

Even after the first year, the PPLI cash value exceeds that of the taxed investment — plus the client's death benefit is over $40 million. After 20 years, the taxed investment is worth $29,449,617 compared to the PPLI cash value of $50,071,060 and a death benefit of $61,086,690.

In addition to the features of a traditional policy, a PPLI policy provides:

  • Fee transparency to the client, unlike the "hidden" commissions of a traditional policy;
  • Investment options, such as hedge funds and private equity (Since only accredited investors can own PPLI contracts, the products are not registered with the SEC.);
  • Very low cost for insurance and other policy fees (the cost of insurance, mortality and expense charges, commonly average around one percent or less over the life of the contract);
  • More efficient cash value compounding with the low cost of insurance, the potential performance of alternative investments, and no commissions reducing contributions to the cash value account — especially in the first year.

Asset Protection and Tax Advantages

In addition to its value as an investment vehicle, the interest in PPLI for asset protection has increased. "I've seen clients that have a few million dollars worth of net worth and they're hyper-concerned about asset protection," observes Chesner.

Asset protection in offshore insurance vehicles offers many additional advantages for HNW clients. By using an offshore trust, you don't automatically eliminate federal income, since the client still needs to report worldwide income. However, if the offshore trust owns the PPLI, then those assets grow free of any federal income tax — and free of predators after the client's estate. At the death of the insured, those assets can distribute in a tax advantaged way to the next generation.

"It's absolutely a wonderful solution on so many facets of financial planning design," observes Chesner. Advisors need to consider a client's situation and evaluate "how do we keep this wealth? How do we pass this wealth on? And most importantly, how do we accumulate wealth while they're living in the most cash efficient manner possible? And that's what this product does. And it does it beautifully. You can focus on income tax, estate tax, asset protection with this one solution."

Next month the author divulges how to set up a PPLI policy and paying premiums.

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Lewis Schiff is the principal of Advanced Planning Group, a family office network for advisors. His latest book, The Middle-Class Millionaire, was published in January 2008. View complete details on how to receive a free report on The Highly Effective Habits of Successful Advisors by the authors of The Middle-Class-Millionaire.