Leveraging private placement life insurance as a tax strategy for HNW clients

Advisors are always seeking creative and innovative solutions to help their clients meet evolving needs and long-term goals. With more creative strategies, though, come more complex planning approaches that require a sophisticated lens to assess how it is best applied within a client portfolio.

One prime example of this is Private Placement Life Insurance (PPLI). Many advisors are familiar with PPLI for its tax advantages; however, we often hear from advisors who are unsure of the best way to integrate the product in the context of their client’s planning goals. They are right to take pause with these products, which are incredibly complex and are designed for only a subset of investors. However, they can prove quite valuable for advisors seeking to optimize the right client’s tax strategy.

The use case for PPLI

In broad terms, HNW and UHNW investors between the ages of 35 and 65 and who are in standard health or better may be a good fit. They must also be seeking a tax-focused strategy, specifically aiming to reduce income and capital gains taxes that could create a drag on their investments.

The product is highly specialized. It provides accredited investors with the traditional benefits of life insurance or annuities, coupled with unique investment fund opportunities called insurance dedicated funds (IDFs), which are financial products offered exclusively in the PPLI market. In some instances, the IDF may not meet the client’s needs, in which case an SMA can be used as an alternative. This allows the advisor to design a bespoke program of traditional and private investments, customized to the policyholder’s risk tolerance and long-term goals.

PPLI is subject to strict regulations, with underlying investments needing to be well-diversified and meeting specifications on number of investments and total percentage of each within the portfolio. Additionally, all parties must observe the investor control doctrine, which means that the SMA’s investment advisor has sole investment discretion with no input from the client, a measure to ensure the product is not used for tax avoidance.

Weighing insurance charges vs. taxes

This strategy is pursued as an income and capital gains tax play. Because of this, the fee discussion is incredibly important. The policyholder needs to be aware of the associated fees, including administrative costs and cost of insurance. Additionally, most states charge a premium tax.

As a life insurance policy, the cash value growth is income tax-free, just like any other permanent life insurance policy. Permanent insurance is taxed like a Roth, meaning you can’t deduct contributions, but the internal growth and the disbursements (absent an unforced error) are income tax-free. When pursuing this strategy, investors are essentially trading taxes for insurance charges, and in many cases, the insurance charges could be lower than the tax drag if the investments were made outside of the policy.

Here’s an example: Picture a high trade account that generates significant capital gains.  If those trades took place within a life insurance policy, the gains and losses are not recognized. The policy owner faces insurance charges, but not taxes. And, by lowering the death benefit, they lower the charges.

What PPLI is not

PPLI can serve a valuable purpose in the right investor’s portfolio. It is, at the end of the day, an income and capital gains tax mitigation tool. It is not an efficient estate planning/wealth transfer tool. If the client’s goal is efficient wealth transfer, they would favor a traditional product that favors a higher death benefit. For wealth transfer and estate planning cases, leveraging each dollar for the death benefit drives the decision. But with PPLI, the investor favors reducing the death benefit to reduce charges.  As a best practice, clients should address traditional uses of insurance first and PPLI second.

One of the most important takeaways as it relates to integrating PPLI into a client’s portfolio is the role of the advisor. There are several factors at play – including liquidity, diversification, legal and compliance considerations – making it essential for the advisor to be well-versed on the complex product and well-positioned to effectively deploy it. As the financial landscape evolves, advisors and clients alike must navigate these complexities thoughtfully. Private placements offer a strategic option for those right profiles, provided they are executed with care and expertise.

Chad Druvenga is CEO of CBS Brokerage.