Ultra-high-net-worth U.S. taxable families have a busy fall ahead with choosing how to best utilize the remaining portion of their lifetime exemption gifts. The question families and their advisors face imminently is how much, if any, of their remaining $11.58 million lifetime gift tax exclusion gift to use.
Under current law, a U.S. citizen or resident generally would owe, at death, U.S. estate taxes (levied at a 40% federal tax rate, as well as any applicable state estate or inheritance taxes [subject to jurisdiction]) on assets in excess of $11.58 million, or $23.16 million for a married couple, that are left to their heirs. The law currently also allows a taxpayer to gift that amount to their heirs during their lifetime without having to pay gift taxes (also currently levied at a 40% federal tax rate).
The maximum amount that can be given away, either during lifetime or at death, free of U.S. gift and estate tax has been increasing over the past few decades. In 1997, that amount was $600,000. It became $1 million in 2002, $5 million in 2011, and $11.18 million in 2018. Under the current law, the exemption amount is scheduled to revert to $5 million (inflation-adjusted) on Jan. 1, 2026. Thus, even with no change to current tax law, it would be prudent to utilize one’s lifetime exemption amount before the reduction takes place in 2026.
Further complicating matters is the need for the federal government to raise tax revenue given a debt-to-GDP ratio that is estimated to surpass World War II levels. In response, there have been a variety of proposals circulating Capitol Hill. They range from repealing the rule that allows for the basis of assets to be “stepped up” from their cost to their fair market value as of the date of death, to a significant reduction in the lifetime exemption amounts, to a full repeal of the 2017 Tax Act.
Given the uncertainty around future transfer tax regimes, many of the families that can make lifetime exemption gifts will do so prior to the end of this calendar year.
Once assets are gifted to trust, those assets are generally taxable to the grantor (who is also usually the person who makes the gift). While there are some estate tax benefits for the grantor paying income taxes on behalf of the trust and its beneficiaries, most families, all things considered, would love to find ways to compound the assets with as little income tax friction as possible.
Enter Private Placement Life Insurance (or as it is often abbreviated “PPLI”). PPLI is an institutionally priced life insurance policy. The taxation of life insurance allows for assets (premium deposits) within the policy to grow on a tax-deferred basis during the lifetime of the insured. At the death of the insured, any amount of capital invested plus whatever life insurance risk is placed in the market pay out income tax-free to the policy beneficiary.
In the past decade, investments eligible within PPLI structures have grown and now cover nearly any asset class an institutional investor would desire. Under a PPLI structure, investors can access alternatives such as private credit, hedge funds and private equity as well as registered investments like actively managed mutual funds and passive index funds that each grow tax-free and provide investors with compounding wealth. The growth of PPLI may be best evidenced by the growing investment landscape. SALI Fund Services, the largest Insurance-Dedicated Fund (IDF) administrator for the private placement life insurance and annuity industry, recently reported that there are over 200 non-registered IDFs, or alternatives funds, and 400 registered funds (mutual and index funds) available for investors today.
The annualized cost of PPLI (while highly variable) averages around 50 basis points over the lifetime of the insured (higher in the early years and lower in the later years). Said another way, 50 basis points per year in PPLI fees can eliminate taxation on investment gains for the lifetime of the insured. The math is quite impressive at current tax rates but appears even more compelling when one considers the potential for higher income tax rates as the government looks to raise tax revenue.
PPLI (like all life insurance) by itself has terrific income tax benefits but no inherent estate tax benefits. A PPLI policy owned personally is included in one’s estate. The best practice is to find a source of capital outside of the investor’s taxable estate, likely in trust or partnership, that can own the PPLI policy. Given the income and estate tax benefits of PPLI owned in trust, many high net worth families contemplating and executing lifetime exemption gifts before year-end should consider utilizing PPLI as a tool to gain the greatest leverage out of these gifts for their beneficiaries. Coupling a lifetime exemption gift with an intrafamily loan can allow an even greater premium deposit into a trust owned PPLI.
Aaron Abrahms is a principal at Winged Keel Group and Matthew Wosk is a founder, partner, and CEO of Proficio Capital Partners.
Winged Keel Group is independently owned and operated. Securities offered through M Holdings Securities, Inc., a Registered Broker/Dealer, Member FINRA/SIPC.