Private Placement Life Insurance (PPLI) Policies are Not a One Size Fits All

Written by Gillian McCarthy, CFP®

Life insurance serves the purpose of protecting your family and heirs against the inevitable risk of death. It sounds morbid, but it is imperative because life insurance benefits will help to fill the financial gap your passing will cause your family. Young families, high-income earners, and sole breadwinners are all typical profiles of individuals who should prioritize shopping for life insurance to protect their families. High net-worth families without the traditional needs for insurance may use life insurance as part of their financial planning process to address tax and estate planning gaps. One way high-worth families may use life insurance as part of their strategy is through a private placement life insurance policy (PPLI).

A private placement life insurance policy is a life insurance product that can complement a broader tax and wealth management strategy for high-net-worth individuals. The life insurance landscape is already expansive, confusing, and sometimes expensive before you add PPLI to the mix. Within the standard life insurance landscape, you have policy choices spanning different iterations, from a term to a permanent policy.

Insurance landscape

A term policy will be most cost-effective and is typically the choice for young families with mortgages and other debt they must protect against if a breadwinner passes. A permanent policy will span your lifetime and can offer specialized addendums called riders to add additional protections. A variable life insurance policy has an element of an investment account you can access during your lifetime.

Some individuals find the investment sleeve of a variable insurance policy appealing because they think they can create a better portfolio and build their value. Within the investment sleeve, you are building value within the insurance policy through your premiums and the returns from your investments. The higher your investment return, the more value you will have available to pass on to heirs via the death benefit, reduce future premiums, or tap into via a tax-free loan.

Who?

As the name suggests, a private placement life insurance policy is offered privately and only to accredited investors. Per the SEC, individuals are deemed accredited investors when they meet specific criteria, a net worth of over $1 million, excluding their home, and an income of over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years, and reasonably expect the same income level for the current year. The SEC also defines entities as accredited investors. It is possible to purchase a PPLI through a trust or an LLC, but only if the entity meets the accreditor investor criteria, including owning investments above $5 million.

Beyond the formal definitions, realistically PPLIs are a possibility for individuals who have a net worth in the millions or control a business with revenue that places them in the highest tax bracket. The limitation of who is eligible to purchase these policies in conjunction with the complex investment offerings makes PPLIs a niche solution for a particular situation. Not all insurance agents will specialize in or even offer PPLIs.

Investment exposure

Private placement life insurance policies are variable universal life (VUL) policies. VUL policies fall in the permanent insurance category and include two pieces, mortality insurance, and an investment sleeve. The policy premium will adjust over time based on the investment sleeve’s performance. As premiums become due, they may be subtracted from your investment sleeve. If the investments you select aren’t doing well, you will see higher premiums to make up the difference to rebuild the value you must maintain to keep the policy solvent.

VULs include a few different layers of administrative and mortality fees related to the insurance aspect. There are also fees associated with the investment sleeve, which will vary based on your selections. Your investment sleeve expenses may also include investment administrative or management fees.

Tax treatment

Insurance companies tout the tax advantages of policies. VULs are tax-deferred; in other words, as your investment sleeve grows, you do not pay taxes on the growth along the way. Sound familiar? It should! This is how your Traditional IRA and 401(k) accounts function. Insurance companies also tout the ability to tap into your policy by borrowing without incurring any tax consequences. This treatment differs from your IRA, you cannot borrow from an IRA, and any distributions are subject to tax as ordinary income. You can, however, take a loan from a 401(k), which is tax-exempt, like the VUL. I point this out because insurance companies like to market insurance policies as unicorn solutions that defy tax consequences, but in reality, they aren’t that special.

Nuances to the PPLI make them appealing to high-net-worth investors. The exclusive nature of a PPLI allows for more negotiation and specialization. Fees are one of the areas you can negotiate within a PPLI. As a purchaser, you can arrange the layers of expenses to make the policy more attractive from a cost perspective.

Exclusivity

The investment options PPLIs allow access to are a distinctive feature that makes them different than a traditional VUL. A PPLI can offer many more investment options that range from hedge funds to alternative investments to funds of funds. You would find different investment options in a variable life insurance policy because, as an accredited investor, the PPLI grants you the ability to invest in riskier investments. PPLIs are not registered with the formal regulatory agencies, unlike other insurance policies that offer investment options. Therefore, there is customization in the investment options and customization in their pricing.

The investment selection requires additional due diligence in a PPLI because you have more options. A hedge fund and other alternative investments often come with liquidity requirements. You may be unable to sell out of the assets for a specific number of years. The risks may require more research on your part as they are not necessarily publicly traded and subject to the exact reporting requirements you would expect with an ETF or a mutual fund.

The customization in the investment sleeve of the PPLI is one of the most attractive for high-net-worth investors, in addition to the tax advantages offered by being held within an insurance policy. Insurance policies offer tax advantages from a few perspectives:

Tax deferral of gains
Pass policy value to heirs tax-free
Ability to borrow from cash value without incurring tax consequences

Not the only solution

PPLIs are exclusive, niche, and complex solutions to multiple financial planning problems. However, they are certainly not the only solution. Strategic income and tax planning can be accomplished through cash flow and managing the location of your assets. Planning for generational wealth and future potential tax issues can be addressed through trust planning and other estate planning tools. As our blog, ‘A dynasty trust is a powerful way to protect your wealth for (and from) your heirs’, explains, a dynasty trust may be one way to protect your wealth for or from your heirs.

Sometimes when solutions sound too good to be true, it is an excellent time to bring out the magnifying glass and dig into the details. PPLIs are a unique insurance product and a good fit for a select group of investors. There are many other planning approaches available that can stand alone or work in conjunction with a comprehensive strategy to achieve your tax planning, estate planning, and overall financial planning goals.