Why Investment Advisors Need to Know About Private Placement Life Insurance

Author:Mr Robert Chesner, Jr.
Profession:Giordani, Swanger, Ripp & Phillips, LLP

PPLI is unparalleled as a tax planning tool and it simply cannot be ignored by investment advisors in an increasing tax environment.

With the anticipated expiration of the Bush tax cuts (at least in part) and the implementation of the tax increases related to The Health Care and Education Reconciliation Act of 2010, taxes are going up and going up substantially for high net worth individuals. There are undoubtedly numerous investment strategies being developed in response to the pending tax increase and, as in the past, many will include mechanisms that attempt to convert ordinary income to capital gain income or to defer taxation of investment earnings. And while some of these plans very well may work, they only facilitate the mitigation of applicable tax. For the past fifteen plus years, however, there has existed a strategy that has the ability to eliminate taxes on investment portfolio earnings. The strategy is private placement life insurance ("PPLI"). While it is bona fide life insurance (which has tremendous ancillary benefits discussed below), the tax benefit to investors lies in the advantageous treatment afforded variable life insurance under long-standing and unquestioned tax law. With the pending tax increases, PPLI is a mandatory and a necessary discussion topic for every investment advisor wanting to provide value-added and comprehensive investment advice within the high-net-worth community.

Taxes Are Going Up

The effect of the expiring Bush tax cuts will take place in 2011 and will result in:

Capital gains tax rates increasing to 20% from 15%; and Ordinary income tax rates increasing to 39.6% from 35%. These tax increases will be further amplified in 2013 as a result of the enactment of The Health Care and Education Reconciliation Act of 2010 as follows:

There will be a 3.8% surcharge on net investment income; and Medicare payroll tax will increase to 2.35% from 1.45%. In summary, these tax rate changes will cause ordinary income to be taxed at a top rate of 43.4%, capital gains at 23.8% and tax on dividends will increase to 43.4% from a low of 15% today. Further, state income tax rates will increase in many jurisdictions.

Investment Advisors are Developing Investment Themes

Investment advisors have developed investment themes and strategies as a result of the changing economic landscape and the future increases in taxes including, but not necessarily limited to:

Selling low basis holdings before tax increases are effective (yet this still leaves the unanswered question of what to do with the investment proceeds); Analyzing and recalculating after-tax yields on fixed income holdings, including a closer look at the benefits of municipal bonds given the wider tax spread between corporate and municipal bonds (yet it will be important to consider the associated risk of the potentially higher yield with municipal debt; risk that stems from the financial stress that city and state governments are feeling due to lower tax receipts and economic weakness, coupled with the very real and measurable off-balance sheet risk of funding employee and post-retirement benefits); Considering investment strategies that postpone the realization of ordinary income; and Utilizing more liquid strategies within a broad strategic framework allowing for tactical positioning as economic developments warrant. A Macro View of the Client's Balance Sheet is Necessary

There are many investment advisors (and investment product developers) discussing (and developing) new tax mitigation and tax-efficient portfolio strategies and this will continue throughout this cycle of higher taxation with respect to both wage and investment earnings. While this activity is an excellent and necessary exercise, too often it is done in a vacuum with respect to an investment portfolio. An investment advisor...

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