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Private Placement Life Insurance For Wealth Managers

Using Private Placement Life Insurance As Income and Estate Planning Tools

Although the use of variable insurance policies to invest in sophisticated investment strategies such as hedge funds, hedge fund of funds, real estate, options and commodities is not a new planning strategy, it has received renewed attention in light of the significant increase in federal income tax rates. While hedge funds and other similar investments can offer high net worth individual's attractive risk-adjusted returns, they are often tax inefficient. Private Placement Life Insurance policies accounts not only offer a way to minimize or even eliminate the income tax inefficiencies associated with these and other types of investments, but they can also provide high net worth individuals with a comprehensive means of minimizing estate taxes and maximizing the amount of wealth available for transfer to their families and charity.

How They Work

A Private Placement Life Insurance policy is an investment account within a variable annuity policy that allows the investor (the "Owner") to grow premiums contributed to the annuity in a tax-deferred manner as long as they remain within the policy.

Withdrawals taken prior to age 59½ are subject to a 10% penalty tax. And finally, all policy benefits paid to family members or trusts for their benefit upon the Owner's death are subject to estate taxes as well as income taxes. For these reasons, variable annuities are traditionally thought of as a retirement planning strategy and not as a tax efficient means for transferring wealth to family members.

For the high net worth individual with significant philanthropic goals, however, Private Placement Life Insurance policies provide a very effective vehicle for increasing the amount of funds available for charity both during life and at death.

While withdrawals taken from the policy during the Owner's lifetime will be subject to income taxes, if they are in turn contributed to charity (which may include the Owner's private foundation), the charitable deduction available to the Owner should net out all attributable income tax liability other than the 3.8% Medicare unearned income tax.

In addition, withdrawals received by the Owner will increase the Owner's adjusted gross income to the extent that they constitute deferred gains. This will increase the Owner's allowable charitable deduction and, in turn, the Owner's giving capacity. Finally, upon the Owner's death, if a charity or private foundation is designated as the beneficiary of the annuity, all funds will be distributed free of income and estate taxes.

Example - Benefits of Tax Deferral of Private Placement Life Insurance

To more fully understand the benefit of the tax-deferral aspect of Private Placement Life Insurance, please refer to the table below, which compares a hypothetical portfolio invested at various nominal rates of return in a traditional, non-tax-deferred hedge fund portfolio (the "Taxable Portfolio"), with the same portfolio invested on a tax-deferred basis within a Private Placement Life Insurance structure (the "Tax-Deferred Portfolio").

Additional Considerations and Conclusion

Despite the unparalleled advantages of using Private Placement Life Insurance policies as tax efficient strategies to access alternative investment classes and to maximize wealth passed to family and charity, there are several limitations. While the owner of the policy has significant flexibility in the selection of the policy's underlying investment manager, and many hedge funds and other investment choices are available, in order to satisfy tax rules the policy owner is not permitted to exercise any undue control over the choice of underlying investments.

Furthermore, while Private Placement Life Insurance accounts offer investors the ability to customize their investment options to include investments in a variety of asset classes, the IRS imposes complex and strict investment diversification rules that must be observed in structuring any Private Placement Life Insurance policy.

In sum, Private Placement Life Insurance policies provide comprehensive and unique wealth transfer solutions for high net worth investors and offer such investors access to a variety of sophisticated investment strategies and products.

Private Placement Life Insurance policies are extremely tax efficient and flexible ways to protect assets during life, facilitate the orderly disposition and transfer of assets upon death, mitigate estate tax liability and augment philanthropic goals