by Teresa Kuhn
Living Wealthy Financial
High-net-worth individuals and affluent families looking for alternative investment opportunities often consider private placement life insurance (PPLI). This unique financial tool offers an effective way to invest large sums of cash while also receiving powerful tax advantages and asset protection.
A PPLI policy is a highly specialized and complex product combining the benefits of traditional life insurance with investment options that are not usually available in standard policies. While PPLIs have many advantages, especially for those investors with $5 million or more in investible assets, they are not for everyone. Since these vehicles are designed for wealthier individuals, they have numerous tax implications and potential disadvantages, of which you should be aware.
You may be curious about the viability of adding a PPLI to your portfolio. In that case, you should always consult a qualified financial advisor to ensure that this vehicle is the correct choice for your goals and risk tolerance. Since this kind of insurance is privately issued and is an unregistered securities product, only accredited investors and qualified purchasers are allowed to purchase it. The Securities and Exchange Commission (SEC) rules have specific guidelines for those categories, such as having an annual income exceeding $200,000 (or $300,000 for married couples) or a net worth of over $ 1 million, not including the primary residence.
How do PPLI policies work?
A PPLI has the same general structure as a variable universal life (VUL) policy. Like VUL and other types of permanent life insurance, PPLI has flexible premiums, meaning you’re allowed to pay as much or as little premium as you want, whenever you want. The cost of insurance, or COI, is deducted from the cash value in your policy’s subaccounts, either monthly or annually.
If you want to keep your policy in force, however, you must pay at least enough premiums to ensure there is enough cash value to cover your COI. If your cash value accounts reach zero, your policy will lapse.
The agent designing your PPLI will typically structure the policy to maximize its cash value growth while keeping the death benefit low. Having a lower death benefit reduces your cost of insurance. You would then pay as much premium as possible into your policy every year to keep it growing.
With PPLI and other types of permanent life insurance, you will get some incredible tax advantages. These include tax-free death benefits for your beneficiaries, tax-deferred growth of your cash accounts, and, in some cases, tax-free dividend growth.
Meanwhile, you’ll also have liquidity since your accumulated cash values can be used for any purpose and withdrawn at any age. Due to the unique structure of these policies, there are no penalties for taking out the cash value before turning age 59 ½.
When does PPLI make sense?
PPLI was created for those wanting to invest in hedge funds but who don’t like the high taxes associated with those funds. Combined federal and state income taxes, along with capital gains taxes, can consume over 50% of a person’s income in some places. When a wealthy investor in a very high tax bracket wants to invest in hedge funds anyway, they may want to fund a PPLI to shelter themselves from taxes. Many family offices, foundations, trusts, corporations, and banks use hedge funds and money management firms to create custom life insurance contracts as a method of reducing their taxes.
The blend of investing and life insurance offered by PPLI makes the most sense for those affluent individuals desiring tax-advantaged growth or building a more tax-efficient legacy for their heirs. For this reason, PPLI is a popular choice for estate planning and asset shielding.
Also, since PPLI is private, it offers a greater level of confidentiality than other types of investments. PPLI policyholder information is largely shielded from public access.
The ideal candidate for a private placement life insurance policy is someone with an annual income that’s in the millions, someone whose net worth is $20 million or more, or someone who controls a multi-million dollar business. A PPLI investor should also have at least $3 to $5 million to fund annual premiums over several years, the desire to own alternative investments, high state, local, and federal taxes, and the desire to shelter assets from creditors.
It’s critical to overfund your PPLI in the first several years. That’s because if your underlying investment subaccounts perform well enough, your policy’s cash value could cover your cost of insurance. At that point, you could stop paying the premiums if you wanted to.
The mechanics of PPLI investments
As mentioned, PPLI policies usually work best for investors who generate a lot of current taxable income, “phantom” income, or capital gains. PPLI policy owners work with their advisors to choose specific assets for their portfolios. Or they may select qualified money managers to handle their portfolios within the PPLI policies. Possible investments often include alternative assets such as venture capital, real estate investment trusts (REITs), private equity funds, and hedge or commodity funds. Depending on goals or risk tolerance, the PPLI investor could also include any fund with an extremely high turnover rate that generates significant short-term capital gains.
While the variety or flexibility in a PPLI is a desirable feature, that does not mean that the IRS will allow just anything as an investment option.
A PPLI policy must still meet IRS rules and standards and offer investor control, insurance, and diversification. For instance, the IRS prohibits individual policy owners and family offices from influencing their fund managers. If the IRS suspects a policy owner is controlling the policy too much, they could rule to withdraw the PPLI’s tax advantages. Fund managers must operate independently.
PPLIs also have some stringent diversification rules attached. These include:
- A single investment cannot make up more than 55% of the policy’s subaccount.
- No TWO investments can make up more than 70% of the portfolio.
- Three investments cannot make up more than 80% of the portfolio.
- And four assets can’t be more than 90% of the total assets in the PPLI account.
For the IRS to fully consider a PPLI as life insurance, there must always be at least five different investments in it.
How do you access cash in a PPLI?
One of the most attractive advantages of a PPLI policy is that the owner can withdraw a specific amount of their cash value or borrow against it anytime, for any reason, without penalties or taxes. Withdrawals from a policy are tax-free up to the cash value (“basis”). Owners can receive their premiums, minus any fees, without tax consequences as long as the subaccounts have performed well enough to cover the cost of insurance. If, however, the cash value is more than the owner’s basis, the IRS will tax any withdrawals over that amount as gains.
Another notable advantage of PPLIs is that a policy owner can borrow against the cash value of the policy with little to no underwriting and no credit checks. The cash value secures policy loans. The ability to get this kind of loan makes PPLI an intelligent choice for emergency funds. You are not required to pay the loans back, either. However, you might want to replace any cash borrowed from the policy, perhaps with interest factored in. Paying loans back could potentially maximize the long-term tax-free growth of your policy.
Keep in mind that interest does accrue. Also, your loan will reduce any death benefits paid out unless you pay back any borrowed money to the policy.
What the heck is a MEC?
In the past, wealthy individuals discovered they could use life insurance not only to create legacies but also to shelter some of their income from taxes. The practice of using life insurance as a tax shelter became so pervasive that the government decided to set limits on how much an owner could contribute to the policy in a given year. These limits help guarantee that investors will use life insurance for its intended purpose.
Contribution limits resulted in what’s known as the “seven-pay test.” Suppose a policyholder put so much premium into their policy that it would become paid up in less than seven years. In that case, the IRS reclassifies it as a “modified endowment contract,” or MEC. MECs are disqualified from most of the withdrawal and loan tax advantages. While MECS may serve a proper function in some types of estate planning, PPLI investors generally never want their policies to become MECs. Loans from a policy classified as a MEC are taxable as income. Also, if you withdraw money from a MEC before you turn 59 ½, you’ll get hit with an early withdrawal penalty, the same as you would with an early withdrawal from a 401k. Fortunately, a savvy insurance advisor will do everything possible to keep that situation from happening.
Is the government set to target PPLI?
If you’re a wealthier person reading this, you might be excited at the thought of gaining tax advantages and asset protection via a private placement life insurance policy. But, before you chase down your financial advisor and demand the details, you should be aware that the US government, awash in debt, is on a mission to close as many tax loopholes as possible in the next couple of years.
Two recent proposals are floating around that aim to restrict, if not eliminate, the use of private placement life insurance (PPLI) and private placement annuity (PPA) contracts. Senate Finance Committee Chair Ron Wyden (D-Ore) suggested changes in a report issued by the Finance Committee Democratic staff. The Treasury’s so-called “green book” for fiscal 2025 hinted at other possible changes to the PPLI structure. The not-so-subtle title of the Wyden report is “Private Placement Life Insurance: A Tax Shelter Masquerading As Insurance and you can read it here:
What if I don’t qualify for PPLI but want the liquidity, control, and tax advantages it offers?
As you read this, you might be thinking, “Well, this sounds great for the uber-wealthy, but what about ordinary entrepreneurs, business owners, and self-employed professionals? Is there anything similar that people in these categories can use to take advantage of life insurance’s incredible benefits?
The good news for those of you who would like greater tax efficiency, more control and liquidity of your money, and a way to grow your cash with less risk and increased predictability is that a vehicle similar to PPLI is available on the retail side.
While it may not have all the advantages of PPLI, the “infinite banking” version of permanent insurance is accessible to people who may not quite fit the guidelines for PPLI. For example, you might be a self-employed person who isn’t an accredited investor or qualified purchaser but who still wants an efficient wealth and tax strategy.
Summing it up:
A PPLI strategy might make sense for wealthier individuals and families, especially if there is an issue of tax inefficiencies. A PPLI provides unique and powerful tax advantages and converts tax-inefficient investments, such as hedge funds, into more tax-advantaged investments.
Additionally, a PPLI may also have a lower cost of insurance and commissions than many retail life products. PPLIs don’t rely on commission-based salespeople for revenue, so they don’t need to include surrender charges or other fees that eat into the policy’s value. Unlike certain other types of assets, cash-value permanent life insurance is a proven strategy for sheltering assets from creditors. In most states, life insurance and annuities offer strong asset protection. Some states even have unlimited domestic asset protection for these vehicles.
PPLI policies are a complicated product that must be designed, implemented, and monitored diligently to reap the most benefits. These insurance products are not for everyone and are not suitable for people who want to avoid risk or who have under $5 million in investible assets.
Even if you have a financial advisor who understands the concept of PPLI, you should still do as much of your own research as possible to ensure you know both the benefits and the potential pitfalls and limitations. You should also be aware that PPLIs and related investments are now on the government’s radar and are likely to undergo substantial changes in the future.
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