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Portfolio > Portfolio Construction > Investment Strategies

This Insurance Policy Works Like a ‘2-Way Roth IRA,’ UHNW Advisor Says

By John Manganaro

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What You Need to Know

  • Private placement life insurance has the power to convert highly inefficient taxable investments into tax-efficient ones.
  • Using PPLI is easier and more flexible than many advisors and clients think, says Cresset’s Aidan Elliott.
  • Drawbacks include potentially higher fees and possible future regulatory scrutiny.

Private placement life insurance is a potentially powerful solution for wealthy individuals in high tax brackets. Aidan Elliott, a director of alternative insurance solutions at Cresset, likens PPLI to “a two-way Roth IRA with none of the income or age limitations.”

But there are many lingering misunderstandings about how it works, even among advisors who specialize in serving wealthy clients, says Elliott, who specializes in building customized estate planning solutions and sophisticated life insurance portfolios for ultra-high-net-worth families.

“It is of little surprise that something as complex as private placement life insurance would be misunderstood,” Elliott recently told ThinkAdvisor. “In our conversations with clients and advisors across the country, misconceptions surrounding the strategy surface time and time again.”

Prior to joining Cresset, Elliott was a director of private placement services at WealthPoint in Denver, where he served ultra-affluent and entrepreneurial family groups, as well as their advisor teams. In that role, too, Elliott says, even savvy clients and advisors tended to lack key insights about the potential uses and downsides of PPLI.

While not a tool that is suitable for every affluent client, Elliott suggests, advisors hoping to win and retain UHNW clients (and to keep their loyalty through the generations) should study up on PPLI.

What Is PPLI?

Defined most simply, private placement life insurance is a type of variable universal life insurance vehicle that allows investments contained within the policy to grow, all while the income and capital gains taxes are deferred. PPLI policies contain a wider variety of investment options than typical VUL policies.

As Elliott explains, PPLI is well-suited to hold interests in various asset classes, including hedge funds and many other forms of “alternative investments.” By covering these assets in an insurance structure, PPLI has the power to convert highly inefficient taxable assets into tax-efficient investments, especially over longer time horizons.

Life insurance offers significant tax advantages, Elliott explains, starting with the fact that investments grow and compound income-tax-deferred, so long as an underlying policy remains in force. Although withdrawals or surrenders can generate ordinary income if structured improperly, there are ways clients can tap a policy’s cash value tax-free, namely by taking withdrawals up to the amount of their investment in the contract or by taking low-cost loans from the policy.

Ultimately, if a client holds a policy for life and the investments perform well, they will accumulate significant cash value without paying tax along the way. This cash value can provide the policy holder with a variety of benefits, including tax-free withdrawals, enhanced death benefits or funding for children’s education.

Other opportunities when one holds the policy for life include the potential to transfer the death benefit to heirs income tax free, and by placing a policy in a properly structured irrevocable life insurance trust, it is possible to avoid estate taxes as well.

The 5 Big PPLI Misconceptions

In Elliot’s experience, there are five common misconceptions about PPLI that hold back its use.

The first is that, once assets are put into a PPLI structure, they are “hard to use.”

“This comes from the fact that it can be hard to access or use money contained within traditional insurance products,” Elliott explains. “Remember, traditional insurance is the most common, and often only, exposure to life insurance most people have.”

The fact is that PPLI operates differently.

“In reality, using the money in PPLI is easy,” Elliott says. “The owner has immediate access to 90% of the liquid positions within the PPLI account within a few days’ notice, through policy withdrawals and loans.”

The next big misconception is that money in a PPLI placement should be considered “last resort money,” but as noted, such assets are generally much more liquid than money tied up in traditional life insurance. As Elliott notes, there is actually good reason to argue the opposite is true, and that PPLI funds can be a good source of liquidity should other funding sources run dry.

“What better place to find the liquidity you need than from a tax-free account? Better than that, you can replenish the same tax-free account later by repaying that loan you took against it,” Elliott explains. “We like to tell our clients that they should view their PPLI account as a two-way Roth IRA with none of the income or age limitations.”

The third misconception Elliott sees is the belief that implementing PPLI is an irrevocable decision. If anything, he argues, PPLI is one of the most flexible strategies clients can implement, as they can get out anytime they want. This is another area where traditional life insurance causes confusion.

“Unlike traditional life insurance policies, there are no surrender charges, significant up-front fees, or commissions paid when purchasing PPLI,” Elliott says. “So, if you implement a PPLI account and change your mind about it the next day, the cost of unwinding the transaction would be minimal.”

The fourth misconception involves the anticipated tax burden of moving into PPLI strategies.

“Yes, PPLI is a great idea for those with large liquidity events, but for clients who are fully invested, it still makes sense to implement PPLI,” Elliott argues. “For starters, most investors do not have eight- or nine-figure positions with a near zero basis. Instead, they have large portfolios and the basis to match.”

According to Elliott, broadly speaking, the cost of liquidating the positions required to fund PPLI is minimal over time, and for those clients who have a particular aversion to paying taxes to implement, strategies such as using a securities-based line of credit can be considered.

Finally, clients tend to believe that sourcing PPLI at older ages must be really expensive, given the selection bias dynamics that play out in the traditional life insurance marketplace.

“This statement is 100% true for traditional life insurance,” Elliott says. “However, if PPLI is properly structured and managed, its costs will not become an issue no matter how old our clients get. While PPLI is technically more expensive at older ages, this is not an inhibitor to the overall value created by implementing it.”

Potential PPLI Drawbacks

While the aforementioned misconceptions are not rightly counted among PPLI’s potential downsides, Elliott says, there are some issues to consider.

To begin with, private placement life insurance typically comes with higher costs and fees relative to other ways wealthy clients can put their money to work. These costs can include administrative fees, mortality and expense charges, premium loading and investment management fees.

As with all fees, these costs can erode the returns on investments within the PPLI policy, potentially affecting the overall value of the policy, though in Elliott’s experience the tax efficiency and attractive investment opportunities accessible via PPLI make this less of a concern in practice.

Still, it is crucial for individuals considering PPLI to thoroughly evaluate the associated costs and fees to determine if the potential benefits outweigh the expenses. Another consideration is the potential for regulatory scrutiny from the Internal Revenue Service and the existence of real, if remote, public policy risk.

While wealthy people can use PPLI to set up customized cash-value life insurance policies backed by a wide range of assets, under key IRS interpretations, they cannot have control over the manager of the funds in the policy. Running afoul of this standard could result in potential investigations and penalties.

The public policy risk, in turn, is demonstrated by the fact that Sen. Ron Wyden, the chairman of the Senate Finance Committee, recently asked PPLI issuers whether they are marketing PPLI mainly as a tool for ultra-wealthy families to unfairly cut their taxes, and not to provide life insurance.

According to Elliott, it is natural for the government to be on the lookout for bad actors connected to PPLI, but, in his experience, they are few and far between.

Credit: Adobe Stock

John Manganaro

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