Seeking Tax Efficiency with Private Placement Life Insurance Alternatives (PPVUL and PPVA)

As the number of registered investment advisors and their assets under management continue to grow, the need to provide clients with specialized and personalized solutions becomes even more important. Today's high-net-worth clients are expecting financial guidance that goes beyond traditional formulaic solutions.

One potential challenge for investors and advisors alike is finding those options and true diversification in today’s publicly available equity capital marketplace. The number of publicly listed companies in the U.S. has dropped nearly 50% over the past 30 years. According to a KKR report from 2022, there are an estimated 64x more private firms than public,1 and a recent estimate categorizes 87% of U.S. companies with $100M or more in revenue as "privately owned."2 With many high growth firms staying private longer (or never going public) thanks to private equity partners – the opportunity to invest in these companies is limited to select institutions or individuals.

Because of this shift in the corporate ownership landscape, alternative investments, especially private placement investments, have become an attractive option for high-net-worth clients.

Alternative investments (or “alts”) refer to investment options that go beyond traditional stocks, bonds, or cash. They include asset classes such as hedge funds, private equity, private credit, venture capital or special purpose vehicles (“SPV”).

Unlike traditional investments, alts often come with higher investment barriers to entry, making them unavailable to the broader public. Investment minimums can range from hundreds of thousands to several millions of dollars to purchase – and may require accreditation or other financial qualifications to participate. They are also illiquid and less regulated compared to traditional investments.

However, alternative investments may afford more options for high-net-worth clients looking to invest in privately-owned companies, with the potential for wider diversification and higher returns.

Many RIAs struggle with recommending (or don't recommend at all) alternative investment products to their high-net-worth clients. This is partially due to the lack of understanding of alts and the complexity of active management. There is a vast landscape of investment options – and knowing how to navigate them to reap the maximum rewards can be overwhelming for many advisors.

Gaining access to many of these alternative investments may also be a roadblock for financial advisors. Without the right tools and resources, the most desirable investments may potentially be out-of-reach for an advisor. Tax considerations of alternative investments can create another hurdle for many advisors, along with finding a scalable solution to manage and maintain multiple alternative investments.

However, having the right investment partner and platform to address these challenges can be the difference between simply offering your client "a solution" and offering them the "right solution."

Private placement life insurance products are a potential way to provide clients with access to alternative investments, while also providing strategic estate and tax planning benefits.

Private Placement Variable Universal Life Insurance (PPVUL) and Private Placement Variable Annuities (PPVA) are types of estate planning products that are only sold privately. PPVUL and PPVA products are similar to their traditional life insurance counterparts in that they offer clients options for death benefits, annuitized lifetime income, investments for growing cash value, and potential tax benefits. However, after these general commonalities, private placement insurance products can offer more benefits to a high-net-worth client.

The Benefits:

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  Investment options and controls: PPVULs and PPVAs offer access to alternative investments that are not available in traditional retirement and life insurance vehicles. This can include investment choices from thousands of hedge funds, private equity, real estate, or other non-traditional asset classes. Investors and their portfolio managers have more control over the selection of these underlying investment options, allowing for more tailored solutions to meet a client’s specific investment objectives.

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  Investment flexibility/customization: Unlike most traditional retirement and life products, private placement vehicles often use a separately managed account (“SMA”) structure. Instead of selecting from a "fund lineup," an account manager (like an approved RIA) will actively manage the account using alternative investments, with the ability to change investment allocation based on a client's specific goals and overall risk tolerance. This fine-tuning approach to account management allows for individual-level flexibility and potentially better risk-adjusted returns.

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  Opportunity for accelerated growth: Traditional variable life and annuity products often limit the growth of the investment component. There is usually a limited choice of insurance dedicated funds (“IDFs”), along with protective options such as “buffers” that protect against market losses. But with “buffers” comes “caps” – which limits upside growth. With PPVUL and PPVA products, limitations on growth are largely limited by the skills of the investment manager, providing the potential for better returns.

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  Tax benefits: High-net-worth clients may not always understand the tax implications of their investment strategies. In traditional alternative investment accounts that are actively managed (i.e., assets that are bought and sold based on an investment manager's strategy) – when distributions take place, taxes are required to be paid for the year of the distribution. This usually comes out of cash accounts. However, in a PPVUL or PPVA, taxes are deferred until money is withdrawn from the product (e.g., annuitized income distribution, loan on the account, or a complete liquidation). There are no annual K-1s or 1099 tax forms to complete.

For many high-net-worth clients living/working in a state with high income taxes (e.g., NY, NJ, and CA), placing investments into a PPVUL or PPVA can be advantageous, especially if that client retires to a state with lower income taxes (e.g., FL, TX, or NV) when distributions take place.

For clients looking to take advantage of alternative investments, without the tax burden that comes with buying and selling investments in a traditional managed account, a PPVUL and/or PPVA can be a good investment product.

The Potential Disadvantages

It's crucial to note that PPVUL and PPVA policies are not a one-size-fits-all solution. High-net-worth investors might find that the risks and drawbacks outweigh the tax advantages, particularly in certain situations. For instance, younger investors or those who may have premature exits from the contracts can find themselves with substantial penalties.

Similarly, investors who have not maximized other tax-advantaged savings vehicles or who have substantial liquidity needs may benefit from a simpler investment approach.

One must also consider the goals of the investor; for those seeking simple tax-efficient wealth transfer, leverage of the death benefit through the policy may be less valuable than other estate planning tools. High fees and the lack of liquidity in these products can also be off-putting for certain segments of clients, particularly those with a more risk-averse outlook or shorter investment horizons.

It is also worth noting that at the time of this publication, the Senate Committee on Finance is investigating the practices surrounding PPVUL and PPVA policies. This spotlight by the Senate underscores the importance for financial advisors to stay abreast of regulatory changes that could impact the advisability of these products for their clients.

Having the knowledge, or even the ability, to invest in alternative investments alone isn't necessarily the answer to your high-net-worth clients’ financial goals. Understanding the vehicles that alts can be used in, such as PPVUL and PPVA products, can significantly differentiate you. It can become an estate planning or tax planning tool (versus mere investment opportunity) that helps create value for your clients.

Additionally, having access to the right platform with the right technology to select the right blue-chip funds is key to maximizing the success of alternative investments.

For financial advisors of high-net-worth clients, offering guidance, education and access to private placement variable life insurance and private placement variable annuity products can create that competitive edge.

Sources:

1. Gartner unveils top predictions for IT organizations and users in 2024 and Beyond. (n.d.).
2. Wulfsohn, J. (2024, February 23). Google admits its Gemini Ai “got it wrong” following widely panned image generator: Not “what we intended.” Fox Business.
3. Generative AI in marketing market size, share and forecast 2032. MarketResearch.biz. (2024, January 25).
4. Dylan Thomas, M. I. (2024, March 1). Private equity-backed investment surge in Generative AI defies 2023 deal slump. S&P Global Homepage