Private Placement

Variable Annuity & Life Insurance: Structurally Improving After-Tax Returns

Simply put, income and estate taxes can have a material impact on the investment returns for families with significant wealth. Investments that generate more normalized and predictable return streams often have a high percentage of returns taxed as either interest income or short-term capital gains.

For families that are in the highest tax bracket (39.6% independent of state income tax, which can increase tax rates to above 50% in places such as California, New York, or New Jersey), these investments unfortunately create an undesired partnership with the government (in the form of tax payments), leading to meaningfully reduced growth of investment portfolios over time.

The goal of this whitepaper is to help educate families and their advisors on the benefits of utilizing Private Placement Variable Annuities (PPVAs) and Private Placement Life Insurance (PPLI) to participate in unique investment opportunities while deferring and/or potentially eliminating the income tax associated with these investments.

What are PPVAs and PPLIs and how do they work?

PPVAs

Let’s begin with PPVA’s. An annuity is a contract between you and an insurance company that is typically created to provide a future income stream in exchange for an up-front premium payment. The benefit that taxable investors can achieve while utilizing an annuity is that investments in the annuity grow on a tax-deferred basis. Investors who participate in PPVAs have the option to take income from the annuity, but most will opt out and allow the investments to grow tax-deferred over long periods of time.

There are four primary differences between a traditional annuity and a PPVA;

  • A traditional annuity has a meaningfully higher fee structure of 1.5% versus 0.4-0.65% per annum for a PPVA

  • The minimums to invest in a PPVA are at least $500,000, versus retail annuities that have very low minimums

  • If you are working with a multi-family office versus a broker-dealer the investment options are broader and include a diverse set of alternative investments

    • Pennington Partners & Co, as a fiduciary, can help source and identify new managers compared to having limited options within broker-dealer firms

  • There are no lock-up or deferred sales charges because heavy commissions aren’t being paid from the insurance company to the insurance broker

PPVAs allow investors to accrue investment earnings with no income taxes until you take a withdrawal. Withdrawals are taxed on the earnings portions of the withdrawal at ordinary income rates. It is important to note that funds withdrawn before age 59½ are subject to a 10% federal tax penalty.

PPLIs

Private Placement Life Insurance (PPLI) is a structure that enables families to pass along wealth to future generations income tax free. PPLIs are very effective if utilized in conjunction with an irrevocable life insurance trust, where families can grow their investments both income and estate tax free. Similar to variable life insurance policies, PPLIs can make investments with the goal of building significant cash flow over time on a tax-deferred basis. Like PPVAs, PPLIs can invest in limited partnerships, hedge funds, and private equity funds, along with a variety of very low-cost investment options. The investment options of a traditional whole life insurance policy are much more limited. The biggest differences between PPLI and a Variable Universal Life (VUL) are as follows…

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