High net worth individuals have high-value insurance policies and, as a result, high premiums. Traditional life insurance often isn’t the best route, but there are other options to consider to reduce premiums and tax obligations. Private placement life insurance, premium-financed life insurance, and irrevocable life insurance trusts are three options we most often discuss with high net worth clients.
PRIVATE PLACEMENT LIFE INSURANCE
How does it work?
With Private Placement Life Insurance (PPLI), high net worth individuals/families work with money management firms to create their own life insurance contracts where they can determine the investments inside the policy. These are generally tax-inefficient investments that are much more favorable inside a PPLI where they are not subject to the usual capital gains tax or ordinary income tax. A PPLI policy can be funded with stocks, bonds, hedge funds, or private equity funds. While technically an insurance product, PPLI is also viewed as an investment strategy to minimize income tax.
Who should consider PPLI?
A better selection of investments and the knowledge that the growth will be tax-free makes PPLI appealing to those who prefer alternative investments but want to avoid the significant taxes that come with them. As PPLIs can be very expensive in the early years, candidates generally have a net worth of ~$20M and an annual income in the millions. For example, a policy may be purchased for ~$1M, with annual premiums for the first several years in the $3M-5M range, until the growth within the account can sustain the policy,
What are some of the benefits?
- Higher-risk/higher-return investment options
- Access to cash via withdrawals or policy loans
- Tax-free growth
- Income tax-free payout of death benefit
- Estate tax-free payout if used in conjunction with an Irrevocable Life Insurance Trust
PREMIUM FINANCED LIFE INSURANCE
How does it work?
With Premium Financed Life Insurance, money is borrowed from a third-party lender to pay large life insurance premiums instead of investors using their own capital. This allows for the purchase of larger policies utilizing the borrower’s funds while (ideally) receiving a greater return on investment for the cash that was not used to pay the premiums. To mitigate interest rate risk, borrowers can look for rate caps or even a fixed rate from the lender.
Who should consider Premium Financed Life Insurance?
This tool is often considered by HNW individuals who don’t want to liquidate assets or allocate current income for insurance needs. Borrowers must post collateral to cover when the policy’s cash surrender value is less than the outstanding loan balance of the loan. For those who love leverage and have enough collateral, it is a great option that frees up their capital and allows it to grow instead of being tied up in insurance premiums.
What are some of the benefits?
- Investor’s capital is not tied up in insurance premiums and can continue to earn for them
- Not having to liquidate assets to pay for premiums means avoiding capital gains tax
- Loan interest may be tax-deductible for businesses if set up correctly
- Tax-free growth
- Income tax-free payout of death benefit
- Estate tax-free payout if used in conjunction with an Irrevocable Life Insurance Trust
IRREVOCABLE LIFE INSURANCE TRUST
How does it work?
Although death benefits are not subject to income tax, the death benefit and cash values of a policy are included as part of the estate for estate tax calculations. With an Irrevocable Life Insurance Trust (ILIT), individuals can avoid very high estate tax on the death benefit by transferring life insurance policy ownership to the ILIT, which effectively removes it from the estate. The trust becomes the owner and beneficiary of the policy and makes the premium payments each year. (The funds for which can be gifted to the ILIT annually by the insured.) It is important to note that the irrevocable designation means that it cannot be changed once it is set up and the grantor relinquishes all rights to the assets held in the trust.
Who should consider an ILIT?
Anyone with life insurance who will have a taxable estate should consider an ILIT. While the Tax Cuts and Jobs Act increased the federal estate tax exemption substantially over the last five years (currently at $12.06M for 2022), it is set to drop back to $5M for 2026. [1] There is some protection offered in the form of grandfathered regulations, as noted in a recent article by The Wall Street Journal – “The increase in the exemption is set to lapse after 2025, but in 2019 the Treasury Department and the IRS issued “grandfather” regulations. They allow the increased exemption to apply to earlier gifts if Congress reduces the exemption in the future.” However, additional legislation was recently proposed by the Treasury Department in April of this year which could further complicate how the exemption is treated. [2] An ILIT can provide peace of mind that changing tax legislation and fluctuating exemption amounts will not affect the death benefit for your loved ones.
What are some of the benefits?
- Significant tax savings as it avoids the 40% estate tax
- Tax-free growth
- Income tax-free payout of death benefit
- Gift tax can be avoided by working to stay under the annual exclusion ($16,000 per donee for 2022) and considering multiple trusts
- Premium financing can also help reduce the annual gift
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“Someone’s sitting in the shade today because someone planted a tree a long time ago.” -Warren Buffet |
When net worth reaches $5M, it’s a good time to start exploring options beyond traditional life insurance to determine which high-value life insurance options are right for you and your loved ones. Our partnership with Heritage Family Offices provides a full-service team of tax, legal, and insurance professionals with the expertise to make that happen.
Ready to learn more? Schedule your appointment today.
