For top tier investors, hedge funds and foreign investments offer broad diversification and attractive returns. Because these returns are often taxed at ordinary rates, affluent investors turn to private placement life insurance for tax efficiency.
The reason to invest using a private placement life insurance is to reduce or eliminate income and estate taxes. All gains inside a properly structured PPLI are tax deferred until taken out as a distribution by the investor. If you leave those investments in the policy, and set up an irrevocable life insurance trust, it’s possible to transfer these assets to your heirs with a step-up in basis and tax free (no estate tax).
This is important because hedge funds and offshore investments can be extremely tax-inefficient. Most hedge fund earnings are taxed as ordinary income or short-term capital gains. Federal rates can be as high ast 43.4% and, when you add in state taxes, the combined rate can be near 50%.
The same goes for many types of offshore investments and foreign mutual funds (which may be inside a hedge fund or you may hold directly). Any foreign investment where 75% of the returns are passive, or 50% of the capital is held in passive investments, is a Passive Foreign Investment Company (PFIC). PFICs are taxed at ordinary rates and gains are taxed in the year accrued, not in the year sold.
Likewise, dividends from an offshore investments are often non-qualified dividends for U.S. tax purposes. Non-qualified dividends are taxed at ordinary income rates.
Anyone investing in foreign products or companies generating ordinary income, or PFIC income, should do so through an insurance policy. Gains inside of a Private Placement Life Insurance policy are tax free if held for the life of the insured or tax deferred if taken out as a distribution by the insured.
In most cases, you can use low interest loans against the policy to access the cash during the life of the insured without incurring U.S. tax. Also, you can typically withdraw your original investment in the contract tax free.
But, the real value of a Private Placement Life Insurance policy is in allowing the investments to grow and compound tax free.
Another way to look at the PPLI is as giant IRA without distribution requirements or contribution limits. Investments in an IRA grow tax free (ROTH) or tax deferred (traditional). Add a UBIT blocker corporation to an offshore IRA LLC and you effectively convert investments that would have otherwise generated ordinary income into tax free capital gains.
Like an offshore IRA, a Private Placement Life Insurance policy increases your returns without increasing risk. This “structured alpha” is based on reducing tax costs, not increasing returns.
Note that this article is focused on foreign investments and those returning ordinary income. A PPLI might not be right for U.S. investments taxed as long term capital gains rates. This is because distributions from the policy to the insured are taxed at ordinary rates.
Thus, it would be possible for a Private Placement Life Insurance policy to convert long term capital gains into ordinary gains. Conversely, if held (deferred) for many years and passed to your heirs tax free with a step-up in basis, a PPLI might be efficient for long term capital gains… it will depend on your situation.
A PPLI provides advanced investors a tax efficient management system not available in any other product. It offers the flexibility to invest in hedge funds, offshore companies, active businesses, foreign mutual funds, and offshore passive foreign investment companies without the tax penalties that keep average people from making these investments and realizing these higher returns.
Likewise, a Private Placement Life Insurance policy eliminates “phantom income” from partnerships or PFICs. Because the gains are tax free, there are no issues of taxable income on a K-1 when no actual distribution is made.
I’ll close by noting that PPLI’s offer excellent asset protection benefits. When held inside of an offshore trust, it’s impossible for a future civil creditor to breach your life policy or access your profits.
Add to this the fact that the trustee can retain the right to limit distributions to heirs if they’re being sued, and you will see significant multigenerational tax and asset protection benefits by combining an offshore trust with a PPLI.
These products are only available to accredited investors and qualified purchasers. You must have a net worth of $1 million (excluding your primary residence) or income of $200,000 (single) to $300,000 (joint) in each of the preceding two years to be an accredited investor. You will also need to have at least $5 million in net investments to be a qualified purchaser.
I hope you’ve found this article on Private Placement Life Insurance to be helpful. For more information, please contact me at firstname.lastname@example.org or call us at (619) 550-2743. We can assist you to set up offshore and introduce you to a qualified PPLI agent.
We can also assist you to transfer an existing life insurance policy into a PPLI using a tax-free exchange (called a 1035 exchange).