Reprinted with permission from Practical Tax Strategies.
ESTATE PLANNING
PRIVATE PLACEMENT LIFE INSURANCE: STRATEGIES, ADVANTAGES, AND CONSIDERATIONS FOR HIGH NET-WORTH INDIVIDUALS TERRY LABANT
Hedge funds are tailored to investors who seek greater return through managers who can move more quickly among investment styles and asset classes. This opportunistic investment style, however, often results in substantial portfolio turnover. As a result, hedge funds typically produce short-term capital gains that are taxed at higher, ordinary income tax rates. Income taxes alone can cost more than 50 cents on the dollar when combining the highest federal income tax level (39.6%), federal investment surtax (3.8%), and state income taxes in higher-taxed states. When hedge fund investments are held within a life insurance vehicle, though, investment gains are not subject to tax. This provides the investment greater opportunity to grow and compound when not affected by higher income tax costs. Why? The answer lies in the fact that investments held within life insurance policies are not subject to income tax as they would be if held individually. This income tax exception applies to compounding gains during one’s lifetime as well as the death benefit paid to a beneficiary.
Can everyone seek private placement life insurance? Individuals must pass two tests in order to purchase private placement life insurance (PPLI). They must be: TERRY LaBANT, J.D., is vice president and senior wealth strategist at Calamos Wealth Management in Naperville, Illinois. He has more than 20 years of experience as a tax attorney in the core areas of wealth creation and preservation. At Calamos Wealth Management he provides guidance and planning assistance to individuals and business owners on matters pertaining to tax, estates, and retirement.
1. A qualified purchaser. 2. An accredited investor according to the Securities and Exchange Commission (SEC). The first test can be easy to meet: A qualified purchaser simply refers to an individual who is medically insurable from a health perspective. The second (SEC) test can be harder to meet. An accredited investor refers to someone who earns at least $200,000 annually and has investable net worth greater than $5 million.
Other considerations A typical PPLI policy is funded with a minimum of $10 million, supporting an initial death benefit of approximately $30 million, and requires full premium payment within a shorter (less than seven-year) time period. This structure raises the bar for qualified individual purchasers seeking PPLI; however, this structure also leads to lower (institutional-like) policy fee structures. Individuals also cannot simply choose their own investments that will be held in the PPLI policy. Instead, the issuing insurance company maintains a list of pre-qualified investment choices and vehicles. As a result, individuals have limited choices among the types of hedge funds or private equity they choose to hold within the policy for investment. An individual may be able to take a loan against the policy value without being subject to income tax on the loan amount, provided that the policy is not treated as a modified endowment contract (MEC). A policy may be treated as an MEC when funded rapidly. Still, PPLI purJULY 2016
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properly structured trust vehicle, relinquish all incidents of ownership and thereby avoid estate tax on the policy value. For example, an individual could create an irrevocable life insurance trust (ILIT) to own and benefit from the PPLI. In this case, the ILIT trustee (who is not
under increased scrutiny by the IRS over the years. Charitable lead trusts also have been used to own PPLI policies, but they require careful structuring by advanced estate planning attorneys to operate correctly under current law. n
chasers are typically focused on tax efficiency more than loan access.
the insured) would govern all other decisions; the insured would not maintain any incidents of ownership, and the policy value would not be included in the insured’s estate. The ILIT would provide a means for the insured to shift wealth to heirs tax free while growing its base more tax efficiently through the investment choice (hedge fund) and structure (insurance policy held in an ILIT). Again, the insured would not benefit directly from the PPLI, but the PPLI structure would provide a means to transfer vast wealth to family members quickly and tax efficiently. Some offshore trust structures have been used to own PPLI policies, but these have fallen under increased scrutiny by the IRS over the years. Charitable lead trusts also have been used to own PPLI policies, but they require careful structuring by advanced estate planning ESTATE PLANNING attorneys to operate correctly under current law. n
Do they also provide wealth transfer (estate tax) benefits?
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That depends. Life insurance generally is not subject to income tax as noted above, but it remains subject to estate tax when a person maintains “incidents of ownership” over the policy. For this purpose, an incident of ownership refers to the right to control the policy. Examples of incidents of ownership include the right to change the owner or beneficiary or to borrow against the policy value. Individuals could contribute the PPLI to a properly structured trust vehicle, relinquish all incidents of ownership and thereby avoid estate tax on the policy value. For example, an individual could create an irrevocable life insurJULY 2016 PRACTICAL TAX STRATEGIES ance trust (ILIT) to own and benefit from the PPLI. In this case, the ILIT trustee (who is not
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Sources: irs.gov, Internal Revenue Code of 1986, as amended, Sections 101 and 2042. CCH U.S. Master Tax Guide 2016, CCH U.S. Master Estate and Gift Tax Guide 2016. For more information about federal and state taxes, please consult the Internal Revenue Service and the appropriate state-level departments of revenue, respectively. Opinions referenced are as of March 31, 2016. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Calamos Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Calamos Wealth Management, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Calamos Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. If you are a Calamos Wealth Management, LLC client, please remember to contact Calamos Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/ evaluating/revising our previous recommendations and/or services. A copy of the Calamos Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees is available upon request. Calamos Wealth Management, LLC, Attn: Compliance Officer, 2020 Calamos Court, Naperville, IL 60563-2787 26
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ESTATE PLANNING
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