Check out how the uber-rich will avoid estate taxes:
As many ultra wealthy Americans – those whose net worth is $20 million and over – scramble for places to hide from Democrat plans to hike their taxes, many on Wall Street think they’ve found just the thing, and as Bloomberg reports today the tax oasis is a niche strategy called private placement life insurance, which is was already gaining popularity among the very rich for its ability to shield fortunes from taxes. Advisers to the top 0.1% already say it’s dominating conversations with their clients.
The threat of higher taxes, which President Biden has affectionately called making billionaires and millionaires pay their “fair share”, isn’t the only factor sparking interest in PPLI: as Bloomberg’s Ben Steverman writes, “a little-noticed change in US insurance law at the end of 2020 makes the tool more powerful, at the same time that competition among insurance carriers and advisory firms is giving rich investors more flexibility, lower costs and a wider choice of products on PPLI platforms.”
The math is simple: as long as assets are held in a PPLI policy, they escape taxes, much to the horror of wealth redistributionists like Elizabeth Warren. When the holder of a PPLI policy dies, heirs inherit the PPLI’s contents tax-free, a perk which strikes at the heart of Biden’s plans to get the very wealthy to pay more taxes on their investments, especially on capital gains that currently aren’t levied if assets are held until death.
Daniel Hemel, a law professor at University of Chicago, said that “Private placement life insurance poses a serious obstacle to President Biden’s goal of guaranteeing that high-income individuals pay tax on large gains at least once per lifetime.” He is talking with Democrats in Washington about ways to limit the strategy. “PPLI is a massive loophole — entirely legal, easy to exploit, and politically very hard to close.”
“Clients are very interested in this right now,” said Tara Thompson Popernik, director of research for Bernstein Private Wealth Management’s wealth planning and analysis group. “It takes some education to get them to wrap their heads around the concept, because it’s not just buying life insurance.”
And once they get educated – put money, don’t pay taxes – they like it. That’s precisely why more and more assets are flowing into the PPLI strategy, yet even so it remains a tiny slice of the trillions of dollars held by the richest Americans. The American Council of Life Insurers, the industry’s trade group, doesn’t even track PPLI policies. If Biden and Democrats are successful in passing a reconciliation bill that hikes taxes, the strategy may go more mainstream, at least among those with the most capital gains to protect from the Internal Revenue Service.
To be sure, PPLI has its drawbacks: according to Bloomberg, complicated rules determine whether a PPLI policy qualifies as life insurance — an important distinction because that’s what gives these accounts their tax benefits. The policies can fail if not funded properly over time. Also once assets are inside a PPLI, they can’t be taken out without a big tax bill, but though they can be borrowed against or rolled into another insurance product.
IRS rules also require policyholders give up day-to-day control of their PPLI’s investment choices and the portfolio needs to be diversified in particular ways, hardly a dealbreaker for those who have already made their money and are only seeking to avoid handing it over to Uncle Sam.
On the other hand, qualifying as life insurance comes with unique perks. Death benefits, paid when an insured person passes away, avoid all taxes, and gains on investments held within an insurance policy build up tax-free. The tool can also be combined with other loopholes: Family offices, for example, can buy PPLI policies inside dynasty trusts, which are vehicles that let multiple generations of wealthy heirs avoid the estate tax.
To exploit its advantage to the maximum, advisers try to stuff as much money into a PPLI while paying as little as possible in insurance costs. “Really the point is to not pay a lot for the insurance piece,” Thompson Popernik said.
The bare minimum one needs to start a PPLI policy is about $2 million, but it’s far more common for investors to devote at least $5 million to the strategy, enough to make the administrative and legal startup costs worthwhile. Withdrawing money from a PPLI while you’re still alive is taxable, so billionaires will be sure to only deploy money that they will never need.
In other words, as Bloomberg notes, one has to be extremely wealthy to even think about a tax shelter like PPLI. “Rich people can do things other people can’t,” said Edward Gordon, president of Preservation Capital Partners. Gordon said he’s “so busy it’s not even funny” advising clients on PPLI policies.
It gets better: a Covid-relief law signed by President Trump in December makes PPLI even more attractive as the package contained a provision that changes the interest rate assumptions on life insurance policies. The politically powerful life insurance industry had argued the current rules were unworkable in a low-interest rate environment, so Congress relaxed the requirement for policies to qualify for favorable tax treatment. As Steverman explains, though lobbyists’ primary goal was tweaking the rules affecting ordinary life insurance products, the upshot is that the wealthy can now put more money into a PPLI policy while paying less to an insurance carrier for life coverage.
“You want to maximize every dollar you can put into the policy,” said David Kleinhandler, principal at life insurance advisory firm AskVest. “There’s a lot of opportunity for people to take advantage of these new regulations.”
While PPLIs has spread in popularity, it has been primarily pitched to clients as a place to put investments, like hedge funds or credit products, that generate lots of income taxable at the top rate. These can surpass 50% when you include the top federal ordinary rate of 37% and state and local income taxes in California and New York City. If all investments are subject to the ordinary rates — as Biden has proposed for those earning more than $1 million per year — then a broader array of investments make sense in PPLI policies.
Meanwhile, Democrats in Congress, who are beginning the process of turning Biden’s tax plan into legislation, disagree on how much to hike rates on capital gains. Because of the growing legislative attention, the potential pitfalls and complexity of PPLI, clients who are initially interested sometimes end up thinking twice before committing their money, advisers say.
“This can get very complicated, and there is a percentage of our clients who value simplicity above all things,” said Jon Ripchick, wealth strategist at Ayco, a firm owned by Goldman Sachs Group Inc. that offers financial planning to corporate executives.
So who is the biggest distributor of PPLI services? We doubt it will come as a shock that Blackstone, via its Lombard International subsidiary, dominates the market, but several other firms are now offering the product. To improve their pitch to the wealthy and their most-trusted advisers, some providers are now allowing those advisers to keep control of the PPLI investments. To comply with the rules, PPLI assets need to go in a separate account that clients technically don’t have any input on. But clients often choose their own adviser to manage that fund, and set goals for how they want it invested.
So what happens next? Well, if Democrats want their tax revolution not to be derailed by a simple loophole, one option they have to stop the wealthy from using PPLI to escape taxes is to cap the size of life-insurance death benefits. Another is to write stricter IRS regulations, perhaps further limiting the control that policyholders are allowed to have over investment choices.
Otherwise, as University of Chicago’s Hemel warned warns, PPLI is a “relatively easy workaround that will allow high-net-worth individuals to generate virtually unlimited amounts of investment income while avoiding capital gains taxes during life and at death.”