Eliminate Taxes Using PPLI, a High-Net-Worth Investor’s
Best Strategy

Recent innovations now enable your clients to defer or permanently avoid taxes while investing in highly desirable low volatility hedge funds.

February 21, 2008
Sponsored by Rochdale Investment Management

by Garrett R. D’Alessandro, CFA, AIF®, Chief Executive Officer and President, Rochdale Investment Management

Permanent life insurance has a long history as a tax-advantaged vehicle for long-term wealth accumulation. However, up until recently, the drawbacks of high cost and inadequate investment returns reduced the tax advantages. Recent innovations in the insurance industry now make it cost effective for high-net-worth investors (HNWI) to obtain a personalized portfolio with very attractive investment choices within an insurance structure. Private placement life insurance (PPLI) represents an important financial and estate planning strategy that can help HNWI defer or permanently avoid taxes while accessing highly desired non-correlated hedge funds and other alternative investments.

Essentially, PPLI is a variable universal life (VUL) insurance transaction within a private placement offering, enabling attractive pricing and personalized portfolio management choices that are far superior to most mass-produced VULs. Higher minimum investment levels make this achievable.

PPLI gained acceptance in recent years as regulations clarified permissible investments. Now, a HNWI can access the same sophisticated and exclusive investments, such as low volatility hedge funds, within the context of a life insurance policy. This creates the ability to defer taxes on less tax efficient strategies, gain portfolio diversification benefits, access these assets during one’s lifetime, obtain asset protection and receive an income tax-free death benefit for the estate.

The PPLI policy requires a sound understanding of its structure. There are four main considerations for investors: risk management, tax management, investment choices and cost.

Risk Management. Risk management occurs on multiple levels. First, asset protection: Because of the underlying VUL structure, the assets are held separately from the general account of the insurance company and their creditors. Also, in certain jurisdictions, creditors and litigants cannot access the policy’s cash value or death benefit. Second, the life insurance component preserves wealth for transfer to future generations. Third, PPLI enables wealth creation as well as an inflation hedge, through investment in sophisticated investments including hedge funds, whose appreciation accumulates and compounds tax-free. Fourth, a properly structured policy allows liquidity that permits the owner to remove cash value as well as borrow from the policy tax-free. Finally, because PPLI is held in a separate account, it can be customized to the HNWI’s individual circumstances, to account for their risk profile as well as their overall holdings outside the account.

Tax Management. As long as the permanent life insurance contract complies with the U.S. tax rules, it is entitled to preferential tax treatment. The insurance policy is structured to embody the investments, thus shielding from income taxes the gains inside the policy as well as the death benefit. Additionally, properly structuring the policy allows policyholders to access capital during their lifetimes by withdrawing or borrowing funds, tax-free, from the policy. With proper estate planning, one can eliminate the estate tax as well.

Once the premiums are paid, the investment benefits accrue under the tax laws as follows:

  • The cash value and investment income under the policy grows tax free
  • The policy owner retains tax-free access to the cash value, subject to certain terms
  • The beneficiary is exempt from income tax on the death benefit amounts, including any accumulated investment income

PPLI’s protection of income and capital gains from taxation offers the HNWI the ability to create unparalleled tax efficiency within the policy, substantially increasing the portfolio value as all taxes are avoided and the principal compounds. Within such a framework, a less tax-efficient investment, like low volatility hedge funds, can become a tax-efficient alternative.

Investment Choices. HNWI with $10 million or more in net worth and paying at least $1 million per year in total premiums over three to five years are eligible for private-placement policies. How much one allocates to PPLI is an individual choice. Generally, HNWI use 70 percent of their portfolio to meet working and retirement lifestyle needs and so require some liquidity for that portion; long-term structures such as PPLI can target the remaining 30 percent. Additionally, assets allocated to highly taxed instruments are a logical source of funding for PPLI.

Four portfolio construction principles govern the integration of PPLI into the overall portfolio:

  1. use PPLI to support the investor’s long term financial needs; strategic asset allocation indicates the longer dated assets are used to fund PPLI VUL
  2. select asset classes with high expected risk/return ratios and low portfolio marginal correlation
  3. allocate to asset classes with high tax exposure that benefit from PPLI’s structure
  4. implement using competitive management fees

The tax advantages of PPLI are particularly attractive for low volatility hedge funds. Because hedge funds can generate more short-term gains, it’s better to hold them in a tax-exempt portfolio. Given that policy wealth accumulation is a function of the underlying investments, the ideal hedge fund portfolio is a low-volatility multi-strategy one, constructed to provide returns in all market conditions and be adequately insulated from market shocks. Insurance-dedicated hedge funds mirror the investments of the manager’s existing hedge fund to provide the same or similar risk and return benefits.
Cost. Excluding investment management fees, which would be incurred whether the investment was held inside or outside of an insurance policy, a competitive PPLI policy has annual fees of 0.75 percent to 1.25 percent of the policy’s cash value, substantially less than most VUL policies. The cost savings result from the higher minimum account size. This covers insurance company expenses, structuring and servicing. Additionally, there are legal or advisory fees to set up a policy. Over the long term, it’s clear and compelling to see how the after-tax compounded returns more than offset the lower insurance costs. Payback periods are as short as three to five years. The transparency of the insurance charges enables better control over such expenses.

PPLI offers high-net-worth investors the best opportunity to significantly increase after-tax returns, since the elimination of taxes integrates personalized solutions for risk management, asset protection and estate planning.

Garrett R. D’Alessandro, CFA, AIF®, is Chief Executive Officer & President of Rochdale Investment Management, a private client money manager specializing in personalized portfolio management for high-net-worth individuals and families. For more information, please call 800-245-9888 or e-mail info@rochdale.com.

Sources: “The PPLI Solution” by Kirk Loury, Bloomberg Press, ©2005; “Insuring Against Hedge-Fund Taxes,” by Rachel Emma Silverman, The Wall Street Journal, October 18, 2006.

This publication is for informational purposes only and is not intended to be a solicitation, offering, or recommendation by Rochdale or its affiliates of any product, transaction, or service, including securities transactions and investment management or advisory services. The opinions expressed in this publication should not be considered investment, tax, legal, or other advice and should not be relied on in making any investment or other decision.