Estate-planning professionals should be aware that there are many creative planning opportunities for the use of private placement life insurance (PPLI)1 with trusts. PPLIs are dramatically increasing in popularity as a result of their improved design, pricing and servicing aspects.
What is PPLI?
PPLI is essentially a flexible premium variable universal life (VUL) insurance transaction that occurs within a private placement offering. The private placement component adds extensive flexibility to the VUL product pricing and asset management offerings. Because PPLI is sold through a private placement memorandum, every situation can be individually negotiated and custom designed for the client. PPLI can be for single life or survivorship and is offered only to an accredited investor.2 PPLI has both a death benefit and a cash value (that is, investment account) and is generally designed to maximize cash value and minimize death benefits. Consequently, PPLI is usually designed as a non-modified endowment contract (non-MEC) policy, with four to five premiums versus a single premium policy (that is, a MEC). In this way, cash values can be accessed tax-free during an insured’s lifetime.3 The PPLI cash value is generally invested among a variety of available registered and non-registered fund options (that is, hedge funds, private equity (PE) and other alternative investments).
Generally, investment managers of the client’s choice, even though not on the insurance companies’ previously approved PPLI investment manager list, can be added and/or substituted in the future.4 If the client exercises too much control over the investments, however, then he’ll be treated as owner, and tax benefits will be jeopardized. That being said, the client is generally free to choose the investment managers he desires, but can’t have control over specific investment elections and shouldn’t have a pre-arranged plan with the investment advisor or manager.5 The investments for the cash value must also meet statutory diversification rules, which generally require at least five funds.6 Consequently, an enormous amount of flexibility exists regarding the investment options for the PPLI cash value, and all is done within the insurance rules so that the investment gains within these cash value accounts aren’t subject to federal or state income taxes.
Assuming a reasonable lifetime investment return, the costs of PPLI will generally be much less than the taxes that would have otherwise been owed. PPLI insurance costs generally average about 1 percent of the cash value of the policy.7 This amount doesn’t include the investment manager fees for investing the cash values, which would generally be the same whether within a PPLI wrapper or not. Note that having a PPLI policy owned in a trust or in a limited liability company (LLC) can significantly reduce the PPLI policy cost (see below for further discussion).
The PPLI cash values are as liquid as its underlying investments, but if a trust owns the PPLI policy in certain trust situs jurisdictions, in-kind distributions of both cash value and death benefits will be allowed. For example, if the underlying investments are hedge funds and/or PE in lock-up periods, they won’t need to be liquidated.8 Further, the cash values are in separate accounts and, therefore, aren’t subject to the general creditors of the life insurance companies.9
Previously, PPLI hadn’t been as appealing due to: lack of
The use of modern trusts by the wealthy (that is, the top 10 percent) has increased dramatically from 1995 to the present day.12 In 1995, only 12.5 percent of all gifts were in irrevocable trusts compared to an average of 40 percent today. Additionally, the use of life insurance by the wealthy has increased significantly. Insurance now makes up more than 20 percent of the wealthy’s overall wealth.13 This increase in insurance over time is due to the combination of modern trust structures and the development of domestic PPLI insurance.
State Income Tax Planning
PPLI can be very beneficial to clients in high income tax jurisdictions because:
1) They may have a trust sitused and taxed in a high income tax state;
2) They may be a beneficiary with residence in a high income tax state and, thus, taxed accordingly when receiving trust distributions from a trust sitused in their resident state and/or another state, whether or not subject to trust income taxes; and/or
3) The trust established by a grantor/settlor may be sitused in a no income tax state, but nevertheless, still subject to income taxes in the client’s resident state based on unique state trust income tax laws.
The high income tax states are
Some states have adopted unique trust taxation statutes. For example,
Additionally, many jurisdictions, such as
Zero Tax Dynasty Trusts
In addition to changing the situs of a trust to a no income tax jurisdiction, many clients create dynasty trusts in states without state income taxes on trusts, prompting them to ask, “what about the federal taxes?” Again, PPLI is the answer to minimizing both the federal and state taxes on the income and capital gains on trust assets in the dynasty trusts. Additionally, as previously discussed, the trust distributions made from dynasty trusts sitused in no income tax states to beneficiaries in high income tax states can be both federal and state tax-free to beneficiaries if PPLI is used. Consequently, PPLI allows clients to create zero tax dynasty trusts:
• No federal income taxes (trust income/capital gains and distributions);
• No state income taxes (trust income/capital gains and distributions);
• No federal death taxes; and
• No state death taxes.
This zero tax dynasty trust is popular with both
As a result of the increase in the gift and GST tax exemptions to
The PNS allows for very large insurance purchases based on an arbitrage with the promissory note interest and the trust investments.25 For example, assume your clients, a married couple, first make a gift of
At the beginning of the first year, the trust holds assets with a value to the clients of
If a client dies before the promissory note term is up, the note is included in the client’s estate, possibly at a discount.30 Sometimes, PPLI insurance is purchased to fund the estate taxes owed on a note. Alternatively, term insurance might be purchased for the note term to pay estate taxes owed on the note at death. A self-canceling installment note (SCIN) could also be used, depending on the client’s age, which wouldn’t be included in the client’s estate at death. Note: Take into account that the interest rate charged on the SCIN would need to be slightly higher than the PNS.31
Another option is to use a beneficiary defective inheritor’s trust (BDIT)32 in combination with life insurance. Generally, a BDIT is designed to give the primary beneficiary control and beneficial rights somewhat similar to outright ownership, while providing favorable tax and asset protection advantages of a trust created by another party (usually the parent). Typically, the beneficiary is treated as the owner of the BDIT for income tax purpose, but not for estate, gift or GST tax purposes. For example, a parent would set up a BDIT for a child beneficiary as the primary beneficiary. The child is generally named as a co-trustee, and the trust would be income tax defective as to the child; further, the child would be liable for the income taxes on the BDIT, but the BDIT wouldn’t be in either the parents’ or child’s estate.
The BDIT can also purchase a life insurance trust on the life of the beneficiary or the parent grantor. In this regard, the insured beneficiary could have access to the cash value of the PPLI policy income tax-free during his life, while avoiding estate tax on the proceeds when paid at death, if properly structured and administered. Also, the beneficiary would be able to save federal and state income and capital gains taxes on the BDIT if the trust was invested in PPLI insurance. Generally, a co-trustee and/or special trustee other than the insured beneficiary is used for all aspects of the purchase, administration and distributions associated with the PPLI policy owned by the BDIT, so that there aren’t any estate tax inclusion issues. The BDIT is typically drafted to accommodate an insurance purchase.
Further planning opportunities are available with PPLI at the end of a grantor retained annuity trust (GRAT) term.33 For example, the GRAT remainder could be used to purchase PPLI insurance. This opportunity would be available whether the GRAT remainder stays in trust for the grantor’s children, is distributed outright to the grantor’s children or is sold to a dynasty trust. Purchasing PPLI in these scenarios with the GRAT remainder would result in additional federal and state income tax savings.
Single individuals in
Offshore vs. Domestic Policies
Both domestic and international clients may purchase offshore PPLI policies as an alternative to domestic PPLI. As a result of the evolution of domestic policies and statutes, many clients have elected to stay onshore for their purchase of PPLI. Previously, one reason for going offshore was the domestic premium tax, which was always around 200 basis points (bpts) or 2 percent; however, within the last two decades, several states have lowered their premium taxes significantly (for example,
If there are existing trusts in a state and a client wants to purchase PPLI in these trusts to take advantage of the lower premium tax in states such as
Another reason for previously going offshore was the ability to take loans from policy cash value and/or pay death benefits “in-kind.” If there are alternative investments involved (for example, hedge funds and/or PE) in lock-up periods, payments from the policy could be made in-kind so that the lock-up periods could be maintained.39 Also, DAPTs and their associated asset protection laws have evolved to a very powerful level in
• travel to an offshore marketplace;
• undergo a physical examination offshore;
• complete required documents offshore;
• set up a non-
• take receipt of the policy offshore.
Also, domestic clients purchasing offshore insurance have Foreign Account Tax Compliance Act (FATCA) and other possible filing regulatory requirements (for example, Report of
NRAs and PPLI
Moreover, another potential benefit for an
As previously mentioned, PPLI policies are protected from creditors of the insurance company because they’re segregated into separate accounts. In addition to this protection, clients also desire that their PPLI policies be protected from their own creditors. Many states (for example,
The combination of all of the favorable PPLI product development over the years, combined with the creative uses that have arisen for PPLI insurance, have resulted in large amounts being placed,53 with phenomenal growth projected in 2016 and beyond. Estate planners who aren’t insurance professionals need to be aware of PPLI policies and their many uses for a client’s estate, trust and financial planning. CPAs also need to be cognizant of PPLI insurance to maximize their clients’ tax savings. Additionally, investment professionals need to be aware of PPLI as an option to provide a tax-free wrapper around their investment management. If you don’t buy PPLI insurance, you won’t have PPLI insurance!
1. Internal Revenue Code Section 7702; See
2. Investors in private placement life insurance (PPLI) must be “accredited investors” who are “qualified purchasers.” The accredited investor rules state that natural persons must have a net worth of over
3. IRC Section 7702A. Modified endowment contract (MEC) policies are subject to additional taxation of withdrawals and loans from policy cash value usually based on premium funding levels and timing of premium payouts. A non-MEC policy allows for tax-free withdrawals up to basis and tax-free loans against the balance of the account. Withdrawals in excess of basis are taxed as ordinary income, though a client can access the policy’s cash value without triggering a tax liability by taking a loan against the policy. Contrast with a MEC, in which accumulation within is tax-deferred, but withdrawals and loans are taxed as ordinary income first, and recovery of basis second. Consequently, the initial premium can only be withdrawn tax-free after all of the accumulated gain has been withdrawn and taxed, so the policy owner can’t access the cash value in a tax-efficient manner. See also Loury, supra note 1, at p. 7.
4. See Loury, supra note 1, at pp. 231-256.
5. Ibid., at pp. 193-196; Internal Revenue Service Revenue Notice 2003-92; see also Webber v. Commissioner, 144 T.C. no. 17.
6. IRC Section 817(h); see supra note 1, at pp. 193-198.
7. See Loury, supra note 1, at p. 9.
8. S.D. Codified Laws Sections 58-15-17, -2 and -26.2, -33.
9. See Loury, supra note 1, at p. 25.
10. See IRC Section 7702;
11. Generally, insurance dedicated funds (IDFs) are exclusively offered to insurance companies and exclusively capitalized by multiple insurers’ life insurance or annuity policyholders, and separate accounts are IDFs only available to a specific policy owner’s account and owned by the insurance company.
12. Al W. King III, “Unique and Creative Uses of Modern Trusts Involving Investments and Insurance,” MDRT Annual Meeting 2015,
14. See Wolters Kluwer CCH, 2016 State Tax Handbook (2015); see
15. Ibid.; See also
20. McNeil v.
21. Linn v.
22. See supra note 15.
24. Using a promissory note sale to a defective grantor trust to acquire life insurance and avoid gift, estate or generation-skipping transfer tax exemption consequences. See also King, supra note 12.
25. Al W. King III, Pierce H. McDowell III and
26. Al W. King III and Pierce H. McDowell III, “State Premium Tax Planning?” Trusts & Estates (
27. A similar death benefit would likely result in
28. Note the promissory note sale strategy can be further leveraged using discountable assets (for example, closely held stock, limited partnerships,
S corporation stock, limited liability companies) versus investment assets, so as to receive a discount on the value of such assets (for example, 30 percent) because they’re generally deemed minority interests and unmarketable.
29. The grantor trust requires the grantor to pay income on the trust, but the trust can have a power allowing the trustee to reimburse the grantor on a discretionary basis for income taxes paid by the grantor on behalf of the grantor trust; See Revenue Ruling 2004-64.
30. See supra note 26.
33. See supra note 25.
34. King, supra note 12.
35. Self-settled trusts are generally when the settlor has the ability to name himself as a trust beneficiary of a discretionary trust along with other permissible beneficiaries, while still providing asset protection from settlor’s creditors. The states with self-settled trusts include
36. Al W. King III, “Tips From The Pros: Charitable Giving With Non-Charitable Trusts?” Trusts & Estates (
37. For example,
Asset Protection Trust Statutes” (
38. See supra note 26.
39. See Loury, supra note 1, at p. 290.
40. Ibid., at p. 294.
41. Report of
42. See supra note 23; See Treas. Regs. Section 20.2105-1 (g).
43. See supra note 23.
45. Al W. King III, “Popular Domestic Trust Strategies for International and Cross Border Families,” Third Annual
49. Note that the reporting required by an Intergovernmental Agreement, FATCA and FBAR may still apply.
50. “Leaks on Tap,” The Economist (
51. For example,
52. Al W. King III, “Defend Against Attacks on DAPTs?” Trusts & Estates (
53. See Loury, supra note 1, at p. 19; See also