Wealthy Americans are scrambling for places to hide from plans by Democrats to hike their taxes. Many on Wall Street think they’ve found just the thing.
A niche strategy called private placement life insurance, or PPLI, was already gaining popularity among the very rich for its ability to shield fortunes from taxes. Now some advisers to the top 0.1% say it’s dominating conversations with their clients.
The threat of higher taxes — what President Biden calls making billionaires and millionaires pay their “fair share” — isn’t the only factor sparking interest in PPLI. A little-noticed change in U.S. insurance law at the end of 2020 makes the tool more powerful, at the same time that competition among insurance carriers and advisory firms is giving rich investors more flexibility, lower costs and a wider choice of products on PPLI platforms.
As long as assets are held in a PPLI policy, they escape taxes. When a policyholder dies, heirs inherit the PPLI’s contents tax-free. Those perks strike at the heart of Biden’s plans to get the very wealthy to pay more taxes on their investments, especially on capital gains that currently aren’t levied if assets are held until death.
“Private placement life insurance poses a serious obstacle to President Biden’s goal of guaranteeing that high-income individuals pay tax on large gains at least once per lifetime,” said Daniel Hemel, a law professor at University of Chicago, who’s been talking with Democrats in Washington about ways to limit the strategy. “PPLI is a massive loophole — entirely legal, easy to exploit, and politically very hard to close.”
While more and more assets are flowing into the PPLI strategy, it remains a slim slice of the trillions of dollars held in portfolios of the richest Americans. The American Council of Life Insurers, the industry’s trade group, doesn’t even track PPLI policies. If Biden and Democrats are successful in passing a reconciliation bill that hikes taxes, the strategy may go more mainstream, at least among those with the most capital gains to protect from the Internal Revenue Service.
“Clients are very interested in this right now,” said Tara Thompson Popernik, director of research for Bernstein Private Wealth Management’s wealth planning and analysis group. “It takes some education to get them to wrap their heads around the concept, because it’s not just buying life insurance.”
PPLI has its drawbacks. Strict and very complicated rules determine whether a PPLI policy qualifies as life insurance — an important distinction because that’s what gives these accounts their tax benefits. The policies can fail if not funded properly over time. Once assets are inside a PPLI, they can’t be taken out without a big tax bill — though they can be borrowed against or rolled into another insurance product.
IRS rules also require policyholders give up day-to-day control of their PPLI’s investment choices — a dealbreaker for some — and the portfolio needs to be diversified in particular ways.
Despite the hassles, qualifying as life insurance comes with unique perks. Death benefits, paid when an insured person passes away, avoid all taxes, and gains on investments held within an insurance policy build up tax-free.
The tool can also be combined with other loopholes: Family offices, for example, can buy PPLI policies inside dynasty trusts, which are vehicles that let multiple generations of wealthy heirs avoid the estate tax.
To exploit its advantage to the maximum, advisers try to stuff as much money into a PPLI while paying as little as possible in insurance costs. “Really the point is to not pay a lot for the insurance piece,” Thompson Popernik said.
The bare minimum you’ll need to start a PPLI policy is about $2 million, advisers say, but it’s far more common for investors to devote at least $5 million to the strategy, enough to make the administrative and legal startup costs worthwhile. Withdrawing money from a PPLI while you’re still alive is taxable, so you should only deploy money that you’re sure you’ll never need.
In other words, you need to be extremely wealthy to even think about a tax shelter like PPLI. “Rich people can do things other people can’t,” said Edward Gordon, president of Preservation Capital Partners. Gordon said he’s “so busy it’s not even funny” advising clients on PPLI policies.
Relaxed requirements
A COVID-relief law signed by President Trump in December makes PPLI even more attractive. The package contained a provision that changes the interest rate assumptions on life insurance policies. The politically powerful life insurance industry had argued the current rules were unworkable in a low-interest rate environment, so Congress relaxed the requirement for policies to qualify for favorable tax treatment.
Though lobbyists’ primary goal was tweaking the rules affecting ordinary life insurance products, the upshot is that the wealthy can now put more money into a PPLI policy while paying less to an insurance carrier for life coverage. “You want to maximize every dollar you can put into the policy,” said David Kleinhandler, principal at life insurance advisory firm AskVest. “There’s a lot of opportunity for people to take advantage of these new regulations.”
Even as PPLI’s popularity has spread, it’s primarily pitched to clients as a place to put investments, like hedge funds or credit products, that generate lots of income taxable at the top rate. These can surpass 50% when you include the top federal ordinary rate of 37% and state and local income taxes in California and New York City. If all investments are subject to the ordinary rates — as Biden has proposed for those earning more than $1 million per year — then a broader array of investments make sense in PPLI policies.
Democrats in Congress, who are beginning the process of turning Biden’s tax plan into legislation, disagree on how much to hike rates on capital gains.
Because of the potential pitfalls and complexity of PPLI, clients who are initially interested sometimes end up thinking twice before committing their money, advisers say.
“This can get very complicated, and there is a percentage of our clients who value simplicity above all things,” said Jon Ripchick, wealth strategist at Goldman Sachs Ayco Personal Financial Management, which offers financial planning to corporate executives.
Carriers providing PPLI policies have tried to attract customers by making their platforms easier to use. “Fees are coming down,” Ripchick said. “Investment options are becoming more competitive.”
Market leader
Lombard International, owned by Blackstone Inc., dominates the market, but several other firms are now offering the product. To improve their pitch to the wealthy and their most-trusted advisers, some providers are now allowing those advisers to keep control of the PPLI investments. To comply with the rules, PPLI assets need to go in a separate account that clients technically don’t have any input on. But clients often choose their own adviser to manage that fund, and set goals for how they want it invested.
Hemel, of the University of Chicago, said one option to stop the wealthy from using PPLI to escape taxes is to cap the size of life-insurance death benefits. Another is to write stricter IRS regulations, perhaps further limiting the control that policyholders are allowed to have over investment choices.
Otherwise, Hemel has warned other
