As today's top federal estate tax rate, or "death tax," currently tops out at 40%, proactive planning is needed for high-net-worth individuals who want to avoid nearly half of their estate going to taxes rather than their heirs upon death.1 With sizeable estate tax exemptions currently set to expire on December 31, 2025, combined with today's historically attractive tax rates, there has never been a more ideal environment for wealthy individuals to consider private placement life insurance (PPLI) planning strategies for their heirs.
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Free Guide: How and Why Wealthy Families Use Life Insurance:
Understanding the financial benefits of life insurance strategies
What is the Tax Cuts and Jobs Act and its impact on affluent investors?
The Tax Cuts and Jobs Act (TCJA) is a major tax reform legislation passed in the United States in December 2017.2 It lowered the corporate tax rate, reduced individual income tax rates, increased the standard deduction, limited deductions for state and local taxes, and made several other changes to the tax code.
The law significantly impacted how affluent investors need to plan and manage their finances. Among other changes, it reduced the maximum amount of mortgage interest that can be deducted, eliminated the deductibility of home equity loan interest, and lowered the cap on state and local tax deductions. But, perhaps most notably, it also increased the lifetime estate and gift tax exemption to $12.92 million per individual (nearly $26 million per married couple) in 2023, which is particularly beneficial to wealthy individuals who wish to pass down their wealth to their heirs.3 This enables them to move up to money into a trust outside their taxable estate to avoid future estate tax liabilities.
However, this estate tax provision, along with twenty-two other provisions, is currently set to expire on December 31, 2025, which will result in a tax hike for most investors unless some or all of the provisions are extended. As a result, the estate and gift tax exemption will essentially be cut in half and adjusted for inflation.4 This creates a limited-time planning window for affluent families to take advantage of today's historically favorable tax environment.
What are the tax benefits of PPLI?
PPLI can be an attractive option for investors looking to minimize their tax liabilities. Similar to the concept of Roth conversions for qualified retirement assets, life insurance strategies can provide a highly favorable tax shelter for non-qualified assets. Whether for wealth accumulation, self-lending leverage and wealth transfer, it is a flexible asset class to consider as part of a comprehensive financial plan.
Some of the tax benefits of private placement life insurance include:
- Tax-deferred/Tax-free growth: The policy's cash value can grow tax-deferred and if structured properly, can be accessed income tax free.
- Income tax-free death benefit: The death benefit paid out to your beneficiaries is income tax-free, meaning they won't owe taxes on the amount received.
- Estate tax planning: PPLI can be used as an estate planning tool, allowing you to transfer wealth to your beneficiaries outside of your estate and potentially reduce your estate tax liability.
- Asset protection: In some cases, PPLI can offer asset protection benefits, shielding your assets from creditors and potential legal claims.
Top tax strategies for wealthy families: Using PPLI to create a synthetic step-up in cost basis
Taking these tax benefits a step further, PPLI can be a valuable tool for the ultra-wealthy to accumulate wealth. Similar to how private markets can afford unique opportunities for high-net-worth investors in the equity market, private placement life insurance can also lead to significant benefits by utilizing private networks. Unlike traditional insurance products, PPLI policies are highly customizable, and pricing is individually negotiated.
Part of navigating proactive tax strategies for high-net-worth families is considering the potential trade-offs of paying capital gains today versus the unknown future estate tax rates of the future when assets pass to your heirs. Moving money out of a taxable estate comes with the downside of losing one's step-up and cost basis at death. For instance, if someone owns a diversified investment portfolio worth $5 million, and it grows to $20 million before they die, the entire $20 million investment portfolio gets stepped up to market value for cost basis if it's inside their estate. This is a significant concern causing many individuals to be hesitant to move their assets out of their estate, as they don't want to lose this step up in market value.
On the other hand, leaving assets in one's estate comes with an estate tax exposure. For instance, if the estate exemptions drop from $13 million to $5 million, and an individual has a $20 million portfolio that just received a step-up in cost basis inside their estate, they will have a $15 million estate tax exposure. This creates a lose-lose situation for the individual, as leaving assets in their estate results in an estate tax exposure while moving assets out of their estate results in a capital gains exposure.
However, PPLI can provide an attractive solution because it enables individuals to move their money out of their estate, thereby potentially avoiding the estate tax exposure risk. If invested in a PPLI contract outside one's estate, all death benefits are paid tax-free, effectively creating a synthetic step-up in cost basis, as all invested dollars are paid out as a tax-free death benefit.
Investment flexibility within PPLI
Unlike retail insurance products, PPLI offers an extremely wide range of investment solutions. For example, a marketable securities portfolio that would typically be managed in a taxable brokerage account could be held with the same positions inside of a PPLI contract. Additionally, alternative asset classes such as private equity, Venture Capital, Private Debt, etc. can be held inside of a PPLI contract if structured properly.
How to get started with PPLI
From avoiding unexpected tax consequences to properly designing and maintaining a policy, it's essential to work with a knowledgeable financial advisor specializing in private placement life insurance to minimize costs and maximize benefits.
At Granite Harbor, we have a unique approach to life insurance strategies. We combine comprehensive financial planning capabilities with deep experience in the insurance markets to develop diversified portfolios that maximize the benefits of all available asset classes.
As experts in life insurance and related financial strategies, we help our clients develop reliable, tax-efficient plans to achieve their financial goals.
Ready to rethink your approach to life insurance? Contact us for a complimentary portfolio review and we'll show you how we can help you maximize your wealth, your way.
2 https://congress.gov/bill/115th-congress/house-bill/1/text
3 https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax