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PPLI: Why the Value Far Exceeds the Cost

Posted by James Burns | Oct 06, 2024 | 0 Comments

Private Placement Life Insurance (PPLI) has garnered a reputation for being an exclusive and expensive financial planning tool. Many potential clients dismiss it outright, assuming the costs outweigh the benefits. However, this perception can lead to missed opportunities for significant financial growth, asset protection, and tax efficiency. The truth is, while PPLI does come with upfront and ongoing costs, the long-term value it provides often far exceeds the initial investment. Let's break down the costs and benefits to see how PPLI can be a smart financial move.

Cost Breakdown: What Does PPLI Actually Cost?

It's understandable to question the price of PPLI, especially when compared to more familiar investment strategies. Let's dissect the cost structure and explain what clients receive in return.

  1. Setup Costs:
    The initial setup cost for a PPLI policy generally includes legal, administrative, and investment structuring fees. Depending on the complexity of the policy and the chosen investment strategy, these costs can range from $50,000 to $200,000. While this may seem steep, this one-time cost establishes the policy structure that will allow for long-term tax-deferred growth and asset protection. Here's a breakdown of what these costs typically include:
    • Legal and Structuring Fees ($25,000 - $100,000): These fees cover the drafting of necessary legal documents to establish the PPLI policy. This includes:
      • Policy Design and Structure: Compliance with tax laws, such as IRC Section 7702 (defining the tax benefits of life insurance) and IRC Section 817(h) (covering diversification requirements).

 

      • Investment Structuring: For PPLI policies that include alternative investments like real estate, private equity, or hedge funds, legal advisors must create documents to structure these investments appropriately within the PPLI framework. This process may involve setting up special-purpose entities, like LLCs, to hold these investments.

 

      • Jurisdiction and Regulatory Compliance: Legal advisors ensure compliance with both domestic and international laws, especially if the PPLI policy involves a foreign insurer. Their expertise helps clients navigate complex regulations, ensuring the policy remains compliant and retains its tax benefits.

 

    • Administration and Underwriting Fees ($15,000 - $50,000): Charged by the insurance carrier, these fees cover:

 

      • Underwriting: A comprehensive assessment of the insured's health, financial situation, and intended investments, which determines the policy terms and premium structure.

 

      • Policy Issuance and Administration: Setting up the policy's account structure and ongoing administration, including establishing separate accounts for managing the investments. This process requires sophisticated accounting and tracking due to the diverse nature of investments typically included in PPLI.

 

    • Foreign Jurisdiction Fees ($5,000 - $25,000): If the PPLI policy is issued by an offshore insurer, additional fees may apply for ensuring compliance with international regulations and setting up the policy in a favorable jurisdiction.

 

  1. Ongoing Fees:
    After the policy is set up, there are annual costs to consider, which are usually manageable compared to the benefits. These include:

 

    • Policy Management Fees (1-2% of the Policy's Cash Value): Covering the costs of managing investments within the PPLI structure and maintaining the insurance component of the policy.

 

    • Investment-Related Fees: If the policy includes alternative investments like private equity or real estate, additional management fees may apply. These are similar to fees charged in traditional investment accounts.

 

 

  1. Comparative Costs:
    While PPLI costs might seem high at first, they become more reasonable when compared to other investment strategies. For example, a hedge fund typically charges a 2% management fee and a 20% performance fee, in addition to taxes on gains. Investments made outside a PPLI policy are subject to capital gains taxes upon sale and annual taxes on income and dividends. By contrast, investments within a PPLI grow tax-deferred, potentially resulting in significant savings over time.

 

Value Proposition: How PPLI's Benefits Offset Its Costs

Now that we've laid out the costs, let's examine the value PPLI brings and how it can outweigh these expenses.

 

Tax Efficiency:
One of the most significant benefits of PPLI is its tax efficiency. Investments within the policy grow on a tax-deferred basis under Internal Revenue Code (IRC) Section 7702. This means you won't have to pay taxes on investment gains, interest, or dividends as long as they remain within the policy. Furthermore, if you need to access the cash value, you can do so through loans or withdrawals, typically tax-free, provided the policy is structured correctly.

 

Example: Let's say you invest $2 million through a PPLI policy that grows at an annual rate of 6% over 20 years. Without the tax deferral offered by PPLI, the taxes on capital gains and income would significantly reduce your returns. However, by growing your investments tax-free within a PPLI, your net returns are maximized. Over 20 years, the compounded tax-deferred growth could add hundreds of thousands—or even millions—of dollars to your wealth.

 

  1. Asset Protection:
    PPLI also provides asset protection benefits. In many jurisdictions, assets held within a life insurance policy are shielded from creditors. This feature adds an extra layer of security to your investments, safeguarding them against unforeseen financial setbacks. Additionally, PPLI can be an essential component of an estate plan, allowing the policyholder to pass wealth to beneficiaries in a tax-efficient manner, often free of income taxes.

 

  1. Estate Planning Advantages:
    The death benefit provided by PPLI can be a crucial tool in estate planning. When structured correctly, the death benefit can be received tax-free by your heirs, helping to avoid probate and estate taxes. Creating an Irrevocable Life Insurance Trust (ILIT) to hold the PPLI policy can exclude the policy's proceeds from the policyholder's taxable estate, preserving wealth for future generations.

 

  1. Long-Term Growth:
    With the ability to include various investments such as private equity, real estate, hedge funds, and more, PPLI offers a flexible investment platform. By maintaining these investments in a tax-deferred structure, the overall growth potential is enhanced. Over a long-term horizon, the compounding effects of tax-deferred growth can significantly outstrip the initial and ongoing costs of the policy.

Client Success Story: The Value of PPLI in Action

Let's illustrate these benefits with a real-life example. Meet David, a successful entrepreneur with a net worth of around $10 million, mostly tied up in investments and real estate. Initially, David hesitated to consider PPLI because of the perceived high setup cost of $100,000 and ongoing annual fees of 1.5% of the policy's cash value. However, after an in-depth analysis of his financial situation, he decided to move forward.

Fast forward 15 years, and the value of David's investments within the PPLI policy had grown significantly, compounding tax-free at an average annual rate of 7%. By growing his investments within the PPLI's tax-deferred environment, he avoided substantial capital gains taxes that would have otherwise reduced his returns. Additionally, the policy allowed him to access the cash value through loans without triggering taxable events.

By the time David was ready to retire, the tax savings and compounding growth within his PPLI policy had offset the setup and management costs several times over. Not only did David enjoy tax-efficient growth on his investments, but the policy also provided asset protection, shielding his wealth from potential creditors. When David passed away, his heirs received the death benefit tax-free, ensuring a smooth transfer of wealth.

Example Portfolio Structure with $10,000,000 Initial Investment

1. Initial Investment and Growth Assumptions:

  • Initial Investment: $10,000,000 (a one-time investment).
  • Investment Strategy: A diverse portfolio within the PPLI, targeting an annual gross return of 8%.
  • Tax Efficiency with PPLI: Assuming the PPLI policy provides tax deferral, meaning investment growth and income within the policy are not subject to annual taxes.
  • Annual Administrative and Mortality Fees: 1.5% per year within the PPLI structure.

2. Investment Returns and Net Growth:

  • Without PPLI:
    • Gross Annual Return: 8%
    • Tax Rate on Gains: Assuming a 40% combined tax rate on income and capital gains, the after-tax return would be:
      • Net Annual Return: 8% - (8% * 40%) = 4.8%
    • Outcome After 15 Years: With a 4.8% net return compounded annually on a $10,000,000 investment, the portfolio would grow to approximately $20.9 million after 15 years.

 

  • With PPLI:
    • Gross Annual Return: 8%
    • PPLI Costs: Administrative and mortality fees of 1.5% annually reduce the return to 6.5%.
    • Net Annual Return Within PPLI: 6.5% (tax-free growth due to the PPLI structure).
    • Outcome After 15 Years: With a 6.5% net return compounded annually on the $10,000,000 investment within the PPLI, the portfolio would grow to approximately $26.2 million after 15 years.

3. Comparative Breakdown and Savings:

  • Without PPLI: $20.9 million (after taxes) after 15 years.
  • With PPLI: $26.2 million (tax-free) after 15 years.
  • Additional Growth: The use of PPLI provides an additional $5.3 million in portfolio value over 15 years compared to the taxable scenario.
  • Death Benefit: PPLI policies include a life insurance component. Assuming the policyholder is in good health, a PPLI policy with an initial investment of $10,000,000 could provide a minimum death benefit of $25 million or more by the end of the 15 years, which would be passed to beneficiaries income-tax-free under IRC Section 101(a).

4. Loans and Access to Funds:

  • A key advantage of PPLI is the ability to borrow against the policy's cash value without triggering a taxable event. For example, the policyholder could take a $2 million loan against the PPLI's cash value at some point in the future, providing liquidity while avoiding taxes.

5. Administrative and Setup Costs:

  • Setup Costs: For a $10,000,000 PPLI policy, the initial setup cost might be around $100,000 - $200,000, covering legal fees, policy design, investment structuring, and administrative expenses.
  • Annual Management Fees: The typical management fee is 1.5% of the policy's cash value each year.
    • In Year 1: The fee would be approximately $150,000 (1.5% of $10,000,000).
    • In Year 15: With the cash value growing to approximately $26.2 million, the annual fee would be around $393,000.
  • Total Administrative Costs Over 15 Years: The fees are charged as a percentage of the growing cash value. Over 15 years, these fees cumulatively sum up to several million dollars. However, these costs are more than offset by the tax-deferral benefits and enhanced growth within the PPLI.

6. Key Points from the Portfolio Analysis:

  • Significant Tax Savings: The portfolio's additional growth of $5.3 million over 15 years demonstrates the power of tax deferral and the compounding benefits offered by PPLI.
  • Liquidity Options: The policyholder can take loans against the policy's cash value, providing flexibility and liquidity without triggering taxable events.
  • Death Benefit: Beyond the cash value, the policyholder's beneficiaries would receive a death benefit potentially exceeding $25 million, free of income taxes, adding a substantial estate planning benefit.
  • Risk Management: The investments within the PPLI policy can be diversified and managed in line with the policyholder's risk tolerance and financial goals, leveraging various asset classes like equities, real estate, or private equity.

Conclusion:

In this scenario, a one-time $10,000,000 investment in a PPLI policy grows to $26.2 million after 15 years, thanks to the policy's tax-deferred compounding and efficient management of investment returns. Without the PPLI structure, the same investment would only reach $20.9 million due to annual taxation, highlighting a $5.3 million advantage. This additional growth far outweighs the initial setup and annual management fees.

The death benefit of the PPLI policy further amplifies its value, providing a potentially $25 million or more to the policyholder's heirs, free of income taxes. By integrating tax efficiency, asset protection, and estate planning, PPLI presents itself as a cost-effective investment strategy that can deliver significant long-term benefits.

CTA:

Curious if the value of PPLI outweighs the cost? Let's explore it together. Schedule a consultation today to see how PPLI can fit into your financial strategy and provide you with long-term growth, protection, and peace of mind.

Disclaimer: The costs, expenses, and potential performance outcomes discussed are for illustrative purposes only. Each Private Placement Life Insurance (PPLI) case is unique, and the specific design, goals, and circumstances of each client may result in different outcomes. Individual results may vary, and all financial decisions should be made in consultation with qualified professionals.

About the Author

James Burns

James Burns, Esq. is a seasoned attorney specializing in estate planning, asset protection, and tax law. Known for his expertise in Private Placement Life Insurance (PPLI), James helps high-net-worth individuals protect their wealth and achieve tax efficiency, including pre-immigration planning. With over 20 years of legal experience, he offers tailored solutions for estate planning and corporate transactions. James is also a published author and sought-after speaker, recognized for his deep knowledge and strategic approach to wealth preservation.

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