By Lee Sherman
If you’re not a member of the billionaire boy’s club yet, you may not have heard of a secret but perfectly legal way to invest in hedge funds without having to pay taxes on capital gains.
Called Private Placement Life Insurance (PPLI), it can help the extremely wealthy avoid the brunt of Joe Biden’s proposed tax increases. Biden’s plan will raise taxes on individuals with income above $400,000, including raising individual income, capital gains, and payroll taxes. If you fall into this category, now is a good time to start looking for ways to reduce this tax burden.
What is Private Placement Life Insurance?
Private Placement Life Insurance is a hedge fund alternative that shields your assets by stuffing them into a life insurance policy. PPLI attempts to combine the financial advantages of a hedge fund with the tax advantages of life insurance. Hedge funds are less regulated than mutual funds and are therefore free to pursue riskier investment strategies. They require a high minimum investment or net worth so they aren’t for everyone and neither is PPLI. Hedge funds are problematic though because every time you make a trade, you have to take a capital gains distribution which is taxable. With life insurance, your wealth can grow tax free. Wrap the otherwise taxable investment inside a tax-free life insurance policy and you’ll benefit from the death benefit and compound gains, without paying a cent in taxes. Sounds too good to be true? Well there are a few requirements and these policies can be tricky to administer.
First you have to qualify, which won’t be too hard if you are the type of investor for whom this strategy makes sense. As tax shelters go, PPLI avoids the stigma associated with offshore banks, changing citizenship, or asset-based lending (legal but difficult to manage) because it is merely a type of variable universal life insurance policy that is only available to accredited investors. An accredited investor, according to current Securities and Exchange Commission (SEC) regulations is a person with a net worth of at least $1 million (excluding primary residence), or income of at least $200,000 in each of the preceding two years. Married couples must demonstrate income of $300,000 in each of the preceding two years. You or your family trust will also be expected to fund $1 million or more in annual premiums ($3 million to $5 million is typical). So this is definitely a case where you have to be rich to get richer.
PPLI is generally structured as a variable life insurance policy which allows policyholders to determine their own premiums and payment schedule. No matter how you decide to structure it, you’ll have to stay on top of the payments. You are required to pay enough in premiums to ensure that you’ve got enough to cover the cost of the insurance. And whatever you do, don’t let the value drop to zero, in which case the policy will lapse. Your financial advisor can help you structure the policy in such as way as to maintain a positive balance and can work with a money management firm to set this up
Like any good insurance policy, a PPLI provides tax-free death benefits to your heirs but you will also benefit in this lifetime. The assets will grow tax-deferred and you can access around 85% income tax-free whenever you like. Whatever is left over is paid to your beneficiaries tax-free.
Lee Sherman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.