WHAT IS PRIVATE PLACEMENT VARIABLE LIFE INSURANCE?
Domestic Private Placement Life Insurance and Annuity products are non-SEC-registered U.S. tax compliant (IRC Section 7702) flexible premium variable universal life insurance policy (PPVUL) or variable annuities (PPVA) that are offered exclusively to accredited high net worth individuals.* The PPVUL buyer’s goal is typically to maximize the efficiency of cash value growth potential, with death benefits secondary. The value of PPVUL as an investment vehicle is ideally for the most tax-inefficient assets in an investor’s portfolio. Some of the highlights of PPVUL are:
- Investment flexibility – The PPVUL policy owner has access to non-registered investments (for example, hedge funds) and managers not available through traditional products.
- Flexible and lower charges – PPVUL charges and loads are fully disclosed and are generally lower than traditional products, so cash values can compound faster. Also, certain fees in PPVUL may be negotiable depending on the premium commitment.
- No surrender charges – Traditional policies generally have surrender charges that inhibit a policy owner's flexibility; there are no surrender charges with PPVUL.
WHAT ARE THE U.S. INCOME-TAX ADVANTAGES OF LIFE INSURANCE, INCLUDING PPVUL?
- Tax deferral of investment earnings and gains
- Tax-free exchanges between the underlying investment options
- Tax-free withdrawals (up to basis) and tax-free loans from policy cash values provided the policy is a non-MEC under IRS §7702A*
- Income tax-free death benefit to the policy’s beneficiaries
*Loans and partial withdrawals will decrease the death benefit and cash value and may be subject to policy limitations and income tax. Product guarantees, including the death benefit, are subject to the claims-paying ability of the issuing insurance company.
A modified endowment contract (“MEC”) is created when the amount by which the contract death benefit exceeds the policy cash value or “net amount at risk” is less than the minimum allowed by the IRS. A MEC does not receive the same beneficial tax treatment as a life insurance contract. Also, if a life insurance contract becomes a MEC while in-force, the policy holder may be subject to additional taxes and penalties.
WHAT IS A PRIVATE PLACEMENT VARIABLE ANNUITY?
In its most basic form, a private placement variable annuity contract (PPVA) is a financial instrument where a premium is paid to a company in return for a promise to pay a lump sum, periodic withdrawals, or an amount for a specific period of time, subject to investment performance. A variable annuity typically delays making payments until some time in the future. The rules in IRC §72 govern the income taxation of all amounts received under annuity contracts. Except in the case of certain annuity contracts held by non-natural persons, income credited on a variable annuity contract is not currently includable in income.
WHO CAN PURCHASE PPVUL AND PPVA PRODUCTS?
PPVUL and PPVA products can only be sold to "Accredited Investors" and "Qualified Purchasers".
- An Accredited Investor is a person with net worth exceeding $1,000,000 or with annual income of at least $200,000 over the past two years.
- A Qualified Purchaser is a person, or entity, with a minimum of $5,000,000 of investments.
- For PPVUL transactions, Trusts, Partnerships, and LLCs will meet the Qualified Purchaser standards as long as the Trustees and Grantor, or General Partner, or LLC Manager also meet the Qualified Purchaser standards.
- Prospective purchasers must be pre-qualified to verify they meet the above requirements before any sales presentations can be made.
- For PPVA transactions, the contract owner must be a "natural person" or, if owned by a trust, all beneficiaries of the trust must be "natural persons."
HOW MUCH INVESTMENT PROTECTION IS AFFORDED TO THE INSURED?
Insurance policies are not insured by the FDIC. The assets underlying private placement variable insurance policies are deployed in a Separate Account, a separate and distinct legal entity inside the insurance company where the assets directly back specific policyholder liabilities. Assets are still subject to the same investment risks as other equity and/or fixed income investments. Typically, there are no guarantees relating to investment performance. A notable advantage of deploying a Separate Account is that the assets are protected from an insurance company’s general creditors.
Private Placement Life Insurance and Annuities are unregistered products and not subject to the same regulatory requirements as registered products. As such, Private Placement Life Insurance and Annuities can only be offered to accredited investors or qualified purchasers as described by the Securities Act of 1933.
WHY ARE HIGH NET WORTH INVESTORS INTERESTED IN PPVUL?
- Investors acquire PPVUL products for their income-tax-deferred investment opportunities, income tax-free death benefits, access to customized investment portfolios, and investment strategies not found in other retail-based insurance products.
- Selection of alternative asset classes such as hedge funds makes both investment and tax sense. Hedge funds complement a traditional portfolio of stocks and bonds. Since hedge fund returns are often independent of the overall direction of the stock and bond market, these funds can provide diversification of the total portfolio, and hence a more balanced risk-return profile than just stocks and bonds alone.
- Like retail insurance products, investment earnings within a PPVUL policy accumulate on a tax-deferred basis until withdrawn; and there is no immediate tax due if changes in the portfolio are made (such as replacing one fund with another, or rebalancing the portfolio). And, as is the case with retail life insurance products, death benefits are income tax-free. Of course, there is no assurance that any investment will have gains, and this risk must be recognized.
CAN SOMEONE WHO OWNS AN INCOME-TAX-FREE POLICY EXCHANGE THAT POLICY FOR PPVUL OR PPVA?
Yes, under the rules of I.R.C. §1035, an insurance or annuity contract can be exchanged tax-free for another contract as long as the insured(s)/annuitant(s) are the same on both the surrendered and the to-be-acquired policy. Life insurance can be tax-free exchanged to life insurance or annuities. Annuities can be tax-free exchanged only to other annuities. Generally, a new medical exam will be needed for PPVUL. In some cases, the insurance company will waive surrender charges for an internal exchange.
WHAT ARE THE RISKS OF PPVUL AND PPVA?
PPVUL and PPVA are unregistered securities products not subject to the same regulatory requirements as registered variable products.The information presented here is not an offer to purchase or the solicitation of an offer to purchase an investment product and under no circumstances should be construed as a prospectus or advertisement. PPVUL and PPVAs are long-term investments. The value of the investment options will fluctuate and, when redeemed or annuitized, may be worth more or less than the original cost.
Alternative investments, such as hedge funds, involve risks that may or may not be suitable for all investors. These risks include (but are not limited to), the possibility that the investment may not be liquid, principal return, and/or interest rate risk. Diversification does not ensure a profit or protect against loss in a declining market.