Envision a world with no taxes. Think about how much money you could have accumulated—let alone how much you would have saved in accounting fees, underpayment penalties, and even time. Yes, time: the hours you spend managing your tax obligations and coordinating with your advisors. Think about the compounding effect on 50 cents versus a $1 over time, and then multiply that by … well, a lot.
What would this mean to you, your family, and your generations to come? What could it mean for causes, charities, or foundations you care about?
I was speaking with my tax partner, Susan Lash, CPA, about how in 2020 more than 60% of taxpayers paid no federal income tax (taxpolicycenter.org). Now, that was partly due to the pandemic. And it doesn’t imply that they didn’t pay payroll, gas, state, and other taxes. But this figure is high in other years as well. Federal taxes can take the largest bite out of one’s pie—currently 37% and possibly higher soon for the highest earners. And if you live in a state like California, state taxes can add an additional 13.3% to the federal income tax rate of 37% for those earning more than $1 million. This article is about you. Oops: I forgot to mention the investment income tax of 3.8% on investment income of $250,000 or more for married taxpayers filing jointly. What if you did not have to pay this too?
Why You Don’t Hear Much About PPLI
I recently read a great article titled “The Very Rich Already Have a Plan to Escape Biden’s Tax Increase” by Ben Steverman, writing in Bloomberg Wealth and forwarded to me by my CIO, Michael Ashley Schulman. The “plan” referred to in the article is Private Placement Life Insurance (PPLI). It spurred me to write this article.
Reading Steverman’s story, you had to wonder why you don’t hear about PPLI or Private Placement Variable Annuities (PPVA) more often. You certainly hear plenty about whole life, universal life, variable annuities, and other insurance products. In the article are quotes by in-the-know people proclaiming that PPLI is a massive tax loophole, presenting a serious obstacle to President Biden’s goal of guaranteeing that high-income individuals pay tax on large gains. The article also states that PPLI is complicated.
I believe the reasons you do not hear about PPLI or PPVA is that it does not pay high commissions to insurance agents; PPLI and PPVA are mostly fee-for-service arrangements. There are literally thousands of agents out there doing great work, but they can’t make a living educating about and selling PPLI. For one thing, you must be a qualified purchaser to invest in a PPLI or PPVA, and their numbers are few. A qualified purchaser is defined as one who has a minimum of $5 million in investable assets. Compare that to the number of customers for commissioned-based insurance products. Supply and demand.
Not a Loophole. It’s Better
In my opinion, PPLI is not a massive tax loophole. For one thing, you have to invest at least $2 million in premium (cash) within the first four or five years to maximize the deferral benefit and offset the cost of insurance and other fees. In other words, you cannot transfer highly appreciated assets into the tax-deferred insurance wrapper of PPLI or PPVA. To invest such appreciated assets in a PPLI, you would have to sell them and pay tax in the process—an IRS revenue generator—which I would not advise doing. Someone would have to have $2 million or even $5+ million in cash lying around to invest in PPLI or PPVA and receive all the future tax benefits. There are relatively few such people in the U.S.
I believe an investor considering a PPLI investment really should have at least $15 million or more of investable assets. If this is you, imagine taking a slice of the $15 million, say, $5 million, and having your advisor invest that money just as you do now, but without having to pay federal, state, investment income tax, or even estate taxes on that money ever again. In a properly structured PPLI, that is possible. And imagine the ability to compound your returns—because you’re potentially paying pay no taxes—thereby creating more wealth for you and your family. That is the power of PPLI.
Two more key points: Within your PPLI or PPVA, you have the ability for your investment advisor to manage a custom investment portfolio within a tax-deferred wrapper. And with the PPLI policy, you may have the ability to borrow against your own money tax-free. It’s not complicated—if you end up not paying the loan to yourself back, it’s simply deducted from the life insurance death benefit at your passing.
Now, to make this product hum, it’s possible to have your illiquid investments—hedge funds and credit funds, for example, which are subject to ordinary income tax and issuance of K-1s every year—allocated into your portfolio within the tax-deferred wrapper.
For those who currently own variable annuities where expenses can be ultra-high, the minimum investment for PPVA is lower and the expenses can be even lower. If it makes sense, you can do an IRS 1035 tax-free exchange between a high-cost variable annuity and a PPVA.
The possibilities for clients utilizing PPLI and or PPVA are many, but personal and estate planning should be the lead in determining whether these products make sense.
You may not hear about these products from your investment advisor or insurance agent, because they require both advisors to work together to implement—the investment advisor to manage the money and the insurance agent to write the life insurance policy on the life of the client. If you’re a qualified purchaser and your advisory firm does offer these products and planning services, it’s worth your time to take a hard look at PPLI or PPVA.
If you do invest, there’s one more thing you won’t hear about: the taxes you have to pay.
Jim Schlager, CFP
Managing General Partner
Disclosure: The opinions expressed are those of Running Point Capital Advisors, LLC (Running Point) and are subject to change without notice. This is not an offer to buy or sell or a security or a recommendation to buy or sell a security. Forward looking statements cannot be guaranteed. Running Point is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Running Point’s investment advisory services and fees can be found in its Form ADV Part 2, which is available upon request. RP-21-29