Taxes
The Very Rich Already Have a Plan
to Escape Biden's Tax Increase
A strategy called private
placement life insurance is a loophole that one policy expert says is ‘entirely
legal, easy to exploit, and politically very hard to close.’
By
Ben Steverman
September
2, 2021, 1:00 PM GMT+1
Wealthy Americans are scrambling for places to hide from plans by
Democrats to hike their taxes. Many on Wall Street think they’ve found
just the thing.
A niche
strategy called private placement life insurance, or PPLI, was already gaining
popularity among the very rich for its ability to shield fortunes from taxes.
Now some advisers to the top 0.1% say it’s dominating conversations with
their clients.
The
threat of higher taxes — what President Biden calls making billionaires and
millionaires pay their “fair share” — isn’t the only factor sparking interest
in PPLI. A little-noticed change in U.S. 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.
As long
as assets are held in a PPLI policy, they escape taxes. When a policyholder
dies, heirs inherit the PPLI’s contents tax-free. Those perks strike 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.
The Taxes Biden Wants to
Hike
The major elements of Biden's tax plan would raise nearly $3.5
trillion
Source: U.S. Treasury
“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,” said Daniel Hemel, a law professor at University of
Chicago, who’s been 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.”
While
more and more assets are flowing into the PPLI strategy, it remains a slim
slice of the trillions of dollars held in portfolios of 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.
“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.”
PPLI has
its drawbacks. Strict and very 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. Once assets are inside a PPLI, they can’t be taken
out without a big tax bill — 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 — a dealbreaker for some — and the portfolio needs to be
diversified in particular ways.
Despite
the hassles, 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 you’ll need to start a PPLI policy is about $2 million, advisers say,
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 you should
only deploy money that you’re sure you’ll never need.
In other
words, you need 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.
Relaxed Requirements
A
Covid-relief law signed by President Trump in December makes PPLI even more
attractive. 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.
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.”
Even as
PPLI’s popularity has spread, it’s 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.
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 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 Goldman Sachs Ayco Personal Financial Management, which offers
financial planning to corporate executives.
Carriers
providing PPLI policies have tried to attract customers by making their
platforms easier to use. “Fees are coming down,” Ripchick said. “Investment
options are becoming more competitive.”
Market Leader
Lombard
International, owned by Blackstone Inc., 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.
Hemel, of
the University of Chicago, said one option 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, Hemel has warned other tax policy experts, 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.”
