Overview

Donald Trump’s presidential inauguration is barely a week and a half away. It seems difficult to imagine that with a Republican-controlled House and Senate that President Trump he doesn’t get virtually everything that he asks for including repeal of the federal estate tax. If the Republicans can’t manage the repeal of the estate tax while controlling both the House and Senate, it would come as a great surprise.  Query: How many times did the Republicans attempt to repeal Obamacare versus attempts to repeal the federal estate tax? Nevertheless, one of the things that the Tea Party Republicans will insist on is that any tax reduction or elimination remain revenue neutral.

As a teenager growing up in the Panama Canal in the decade of the 1960’s and 1970’s, my connection to American culture came principally through the American military radio and TV station. I gravitated to the horn bands as a result of my participation in band and orchestra. I was a Blood, Sweat and Tears fan and a big fan of Chicago in the early part of their history as a band. In spite of sales in excess of 100 million, it took far longer than it should have for Chicago to make it into the Rock Hall of Fame, reflecting a bias against horn bands. CNN recently presented a documentary on the band’s fifty-year history. Finally, Chicago gets it just recognition! The song of the article takes its name from the band’s song Now More than Ever from the album Chicago II.

The private placement life insurance (PPLI) industry in its short history has had several “starts” and “stops”. The niche industry has had some consolidation in the last five years. One of the trends is that offshore carriers are creating a U.S.-based carrier in order to have the capability of issuing policies domestically. However, the prospect of a better economy along with tax reform offer the potential for PPLI to have a strong resurgence.

Summary of Trump Tax Reform Proposals

Donald Trump’s tax reform proposal offers three marginal tax brackets – 12%; 25%; and 33%. The reform proposal also targets a significant reduction in itemized deductions - $100,000 for single taxpayers and $200,000 for married couples filing jointly. The standard deduction would be increased to $15,000 for single taxpayers and $30,000 for married couples filing jointly.

Some of the discussion related to the repeal of the federal estate provides a scenario where the gift tax remains intact citing the importance of the gift tax from an income tax standpoint regarding the historical cost basis of an asset. The plans include a repeal of the step up in basis of a capital asset at death.

The current rules provide for a step up in basis to the fair market value at the taxpayer’s death or alternate valuation state. The proposal includes a capital gains tax at death.

Summary of PPLI Benefits

Permanent life insurance is the most tax-advantaged investment vehicle on the Planet. The investment growth of the cash value is not subject to current taxation. The policyholder is able to take a tax-free policy loan during his lifetime generally up to 90 percent of the policy cash value.

The net cost of the loan which does not have to be repaid is approximately 25-50 basis points (.25%-.50%) per year. The death benefit is income tax-free and can also be arranged so that it is estate tax-free. In plain English, the policyholder’s account value grows tax-free, can be withdrawn tax-free, and is received tax-free by beneficiaries at death.

A variable life insurance policy is a permanent life insurance contract that has a cash value component and a death benefit component. The growth of the cash value is tied to the investment performance of investment sub-accounts that the policyholder is able to select,. In retail variable insurance products, these investment choices are mutual fund clones or sub-accounts. The policy holder bears all of the investment risk. The assets supporting the policy cash value are separate or segregated from the life insurer’s general account asset and its creditors. The policyholder is able to select these funds within the life insurance policy with the carrier’s fund election form.

PPLI is a form of variable universal life insurance. The policy is strictly available for accredited investors and qualified purchasers as defined under federal securities law. The policy is institutionally priced and is virtually a “no load” product. The insurer provides the policyholder with the ability policyholder to customize the investment options within the policy. The range of investment options can include a customized fund managed by the client’s existing investment advisor as well as a range of asset classes including hedge funds, real estate and private equity.  

In order to appreciate the cost perspective of PPLI, you need to understand the cost structure of retail insurance products. Variable life insurance products have a commission structure that pays the agent 55 -95 percent of the target (commissionable) premium in the first policy year.

Commissions in subsequent years on premiums vary by carrier from 2-5 percent of the premium. Additionally, the agent receives 25-35 basis points (.25-.35 percent) of the policy’s account value each year. The policies usually have declining surrender charges of 10-12 years. These charges allow the insurer to amortize and recoup these sales.

Private placement life insurance and annuities have no surrender charges and compensate the distributor (agent) with premium based commissions equal to 1-3 percent and asset based commissions based on the account value of 25-35 basis points. The impact of these charges creates a “drag” on the investment performance of approximately one percent per year over the life of the policy.

The purchase of private placement insurance products is limited to accredited investors and qualified purchasers as defined under federal securities law. Private placement insurance products are a non-registered security for federal and state securities law purposes. The product is available to accredited investors and qualified purchasers as defined in federal securities law. The Securities Act of 1933 provides an exemption under Section 4(2) from securities registration for accredited investors as defined in Rule 501(a) of Regulation D under the Securities Act. An accredited investor is defined as an investor with a net worth of at least $1 million and joint income of at least $300,000 in each of the last two years, with the likelihood of continuation in the current year.

PPLI offerings are exempt from the Investment Company Act of 1940 under Section 3(c)(1) and 3(c)(7) offerings. Under Section 3(c)(1) the number of beneficial owners is limited to 99 investors.[1] Investors must be accredited investors or qualified purchasers. A qualified purchaser has investable assets of at least $5 million. Under Section 3(c)(7) the number of beneficial owners is limited to 499 investors.[2] The investors must be qualified purchasers. New SEC proposals would exclude the value of an investor’s principal residence from investable assets.

Summary  

PPLI was an interesting planning solution before the Trump presidency, but appears to me to be a more interesting solution after the inauguration. In spite of the reduction in marginal tax brackets, investors will still pay income taxes at relatively high rates once state and municipal taxation are considered.

The unique tax advantages of PPLI provide a method for accumulating investment income without taxation along with the ability to access this accumulation on a tax-free basis through policy loans and withdrawals. The repeal of the estate tax and step up in basis at death favors PPLI in its unparalleled ability to distribute the investment gain at death income tax-free.

In the event the gift tax is repealed, life insurance strategies such as split dollar life insurance paired with PPLI will provide a sophisticated basis for transferring and accumulating wealth on a highly tax-advantaged basis.

Your life insurance agent has been telling for twenty years that life insurance is an exceptional accumulation vehicle largely based on its tax attributes. He was correct than and he is even more correct now. Pending tax reform suggests that the planning utility of life insurance and PPLI may be reaching is Golden Era.