Treasury Proposes Curbs on Use of Life and Annuities in Wealth Planning

The U.S. Treasury Department hopes to keep very wealthy individuals and families from using customized life insurance policies and annuities to cut their taxes.

The department has added a proposal to “Limit Tax Benefits for Private Placement Life Insurance and Similar Contracts” in its “Greenbook,’ or detailed discussion of revenue-raising proposals, for fiscal year 2025.

The proposal would limit the tax benefits for private placement life insurance policies, private placement annuities and some other types of variable life and variable annuity contracts.

What it means: Few Greenbook proposals become law. Even the Greenbook proposals that eventually become law may take decades to affect anyone’s taxes.

But the appearance of the private place life and annuity proposals in the Greenbook could affect the work of the financial services group lobbyists and advisors who help shape federal tax policy for years to come.

The backdrop: Treasury officials develop Greenbook reports every year as a supplement to the president’s annual budget proposals.

The administration of President Joe Biden released a proposed budget for fiscal year 2025 Monday. Federal fiscal year 2025 starts Oct. 1.

Greenbooks issued in the past have included proposals for limiting use of business-owned life insurance programs and use of life insurance-like arrangements that fail to meet the IRS life insurance policy requirements. The authors of the new Greenbook put the private placement life and annuity proposal after the description of the proposal for changing the rules for failed life contracts.

The new private placement life and annuity proposal could generate $140 million in extra revenue in fiscal year 2025 and $6.9 billion over the period from 2025 through 2034, according to an estimate in the 2025 budget.

Private placement life insurance and private placement annuities: PPLI and PPA arrangements are life and annuity products designed for customers who are paying so much that the program managers can customize the benefits, premium payment rules and investment portfolios.

In some cases, the customers can use stakes in companies they own to pay part or all of the premiums. In other cases, managers of the portfolio supporting a product might invest part of the portfolio in the product owner’s own company.

The proposal: Officials say in a discussion of the new private placement life and private placement annuity proposal that policyholders with a net worth of $20 million or more are using the arrangements mainly to generate tax benefits, not to provide mortality or longevity protection.

The proposal would change the rules by creating a new class of “covered contracts,” including:

1. Any domestic product now classified private placement life insurance policy or private placement annuity contract.

2. A variable life contract with premiums paid in kind, rather in cash.

3. Any variable life contract with underlying assets purchased, directly or indirectly, from the policyholder or related persons.

4. Any variable life insurance contract issued outside of the United States if a domestic version of the policy would be classified as a private placement life insurance policy.

For a covered contract, “in addition to partial or full surrenders of cash value, distributions would include amounts payable as death benefits, amounts received as policy loans, and amounts of policy cash value assigned or pledged to any person,” officials write.

Today, beneficiaries of a life insurance policy can usually get the benefits and many other kinds of distributions free from federal income taxes.

Under the proposal, clients could continue to pay ordinary income taxes on distributions coming out of a private placement annuity after the annuity payment start date.

If beneficiaries received death benefits because the individual insured by a covered contract died, those payments “would be taxable as ordinary income, but only to the extent the beneficiary’s share of the contract’s investment value exceeds the beneficiary’s share of the contract’s investment in the contract,” according to the Greenbook. “A contract’s investment value and investment in the contract would be allocated to multiple beneficiaries in proportion to the allocation of the death benefit itself to those beneficiaries.”

In most other cases, recipients of the cash taken out of the arrangements would pay ordinary income taxes along with a 10% penalty.

The U.S. Treasury Building in Washington. Credit: Bloomberg