Despite recent volatility in the U.S. stock market, the rising costs of inflation, and the Russian invasion of Ukraine, there are still ways to control the taxes you pay on your investments and the taxes that your family will pay when you're no longer here. One tool that has been used by wealthy families for several decades allows for the deferral of federal and state income taxes on investment portfolios. This tool, known as private placement life insurance (PPLI), is composed of your investment portfolio and an insurance component designed to deliver the minimum amount of insurance protection at the lowest cost, allowing the maximum tax benefit.
A PPLI policy may be structured to include stocks and bonds, hedge funds, and private equity funds. Section 7702 of the Internal Revenue Code allows the cash value of the PPLI policy to grow free of income tax. In addition, if the PPLI policy is owned by an irrevocable trust, the life insurance benefit tied to the portfolio can potentially escape the federal estate tax, which has a top rate of 40%.
Investment portfolios often consist of tax-inefficient investments. An example is an alternative investment such as private credit that pays a current yield. In places like California and New York, investors in high tax brackets would give up 50% of their return. By contrast, in a PPLI structure, the tax is deferred and potentially eliminated, allowing the money to grow and compound much quicker. In addition, some of these investments are not directly correlated to the stock market.
Certain individuals have adapted to the current market volatility by repositioning their assets and avoiding taxes on their portfolio going forward. In some situations, the recent market correction opens the possibility of harvesting a tax loss, creating a current-year tax deduction, and positioning those investments going forward so they are not subject to federal and state income tax. Most of the policies are designed to require that a dollar amount goes in each year over a series of years. This can be beneficial during volatile markets because it forces dollar-cost averaging.
Some advisors describe this approach as creating a rainy-day fund. The growth of the fund is maximized by setting it on the sidelines and allowing it to grow and compound tax free. Then, when needed, there are different ways to access the fund without triggering taxes. Having this separate bunker of tax-efficient investments can create an additional layer of safety and peace of mind without being subject to the confines of a typical life insurance policy.
PPLI may be a good fit for those individuals who would prefer to tailor the investment options of the PPLI to meet their needs and wants versus what is normally dictated by an insurance company. PPLI may also lower insurance costs and, in some cases, eliminate the need for typical life insurance products for many families. While PPLI may mitigate certain taxes, it is important to remember that PPLI is life insurance first and foremost.
The recent volatility caused by global events should be a call to action for individuals to consider other planning options. Beyond PPLI, a reset in any investment value can be an opportune time to consider many different types of estate and income tax planning techniques and other strategies. One of the most effective ways to protect yourself and your wealth is to work with your trusted advisors to stress test a variety of outcomes for your investments and your overall planning to be sure that you are set up to get the results you want, and you are not missing any opportunities.
As always, Venable is committed to helping our clients maximize tax savings in a complex, ever-changing landscape. Please contact Venable's Tax and Wealth Planning team if you have any questions or concerns regarding your specific estate plan and PPLI.