How to Use a Life Insurance Wrapper to Minimize Taxes on Securities Investments

Owners of life insurance policies are not taxed on the growth of investments held by those policies. In addition, these owners can access funds within those policies without tax consequences, through loans and withdrawals.

A private placement, variable life insurance wrapper (private placement wrapper) offers investors an opportunity for substantial tax-free buildup of investment benefits, while still allowing access to funds. Private placement wrappers should be set up as nonmodified endowment contracts in which premiums are paid over several years. If the premiums are paid all at once through a modified endowment contract, loans from the policy would be taxable.

In essence, a private placement wrapper places investments a taxpayer might make anyway inside a life insurance contract, thus combining sought-after investment results with the tax advantages of a life insurance policy. Taxpayers can select an investment adviser to manage the assets (e.g., a hedge fund manager). The choice must, however, be approved by the insurance company underwriting the private placement wrapper.

In essence, instead of purchasing investments, a taxpayer pays premiums, which are invested by the insurance company through an investment adviser the taxpayer selects.

Private placement wrappers are generally appropriate only for high-net-worth individuals and have minimum premiums of several million dollars. Wrappers are usually written with an offshore insurance company to avoid state premium tax and deferred acquisition tax, which total approximately 4%. Offshore wrappers do incur a 1% excise tax for transferring assets offshore.

Negotiate Lower Expenses

Because insurance companies keep separate accounts for variable life policies (which are treated as a separate line of business), insureds can negotiate low load (surrender) charges.

While retail variable life products may have load charges that exceed 100%, insureds under private placement wrappers can negotiate load charges of less than 10%. Individuals seeking private placement wrappers can also reduce other expenses (such as the mortality premium) as these fees, too, can be customized for variable life products.

Investments within a wrapper must be diversified, and a certain portion of the premium must be used to pay for the cost of insurance (COI). The COI is an amount comparable to a renewable term insurance policy for the pure mortality risk represented by the policy.

In addition to income tax benefits, private placement wrappers also offer the same estate tax benefits that insurance policies have always offered. Irrevocable life insurance trusts or private split-dollar plans are two possible strategies. Because there are pros and cons to each of these estate planning gambits, a taxpayer should discuss them with his adviser to ensure that they fit his needs.

Raising the Issue

Often, a taxpayer wishing to explore a private placement wrapper must raise the issue directly with his insurance adviser; in general, life insurance companies do not publicize them (especially the tax benefits), to avoid the attention of regulators. Further, insurance agents do not promote the product aggressively, because lower loads and expenses negotiated in the process of establishing a private placement wrapper generally mean lower commissions for the agent.

Private placement wrappers offer an effective method for meeting both a taxpayer's insurance and investment goals, while minimizing overall income and estate tax exposure. For high-net-worth individuals, they are an option worth exploring.

From Israel Press, CPA, New York, NY