Many people use their last will and testament to make bequests to charity. However, there may be a better way to optimize the assets while maintaining control of them.
Let’s look at the story of a generous 65-year-old widow. She had a sizable investment portfolio that would be left to charity; however, she wasn’t comfortable giving her wealth away until she passed. She considered outright gifts and contributions to a donor-advised fund (DAF) or charitable remainder trust (CRT), but ultimately decided that she was not ready to part with control of the assets for fear she may need them someday and would regret the irrevocable donation.
The first alternative was to simply retain the assets and give them away through her will at her death. The downside of this strategy was that she would incur tax generated by investment gains in the portfolio. It was bothersome to her that she would pay income tax on money that was ultimately going to be left to the foundation.
An advisor suggested another solution—a Private Placement Variable Annuity (PPVA)—which accomplished all her objectives. A PPVA is a uniquely flexible financial tool that ultra-affluent, U.S. taxpaying families are increasingly integrating into their charitable planning strategy because it can eliminate income taxes generated by investment gains, while still allowing the owner to maintain control of the assets during their lifetime.
The investments inside a PPVA account grow income-tax-deferred, and investment options include both alternative and traditional asset classes, such as direct lending, opportunistic credit, hedge funds and mutual funds. The owner maintains complete control over the PPVA during their lifetime, including the right to take distributions and change the beneficiary.
Key Features of a PPVA
- Defer income tax on investment gains
- Eliminate income tax by leaving assets to charity
- Maintain control of assets through owner’s lifetime
- Access alternative and traditional asset class investments
- Leave a significantly larger legacy for charity of choice
If the beneficiary is a private foundation or public charity, it receives the proceeds of the PPVA income-tax-free. The beneficiary (charity) can be structured so that the charity receives the assets either at the death of the initial owner or after the PPVA proceeds have been “rolled over” to a surviving spouse. The latter results in additional years of tax-free compounding, often resulting in significantly larger balances going to the charity than if the payout was made at the death of the first spouse. If the values of the PPVA are accessed by the owner during their lifetime, the gain is taxed as ordinary income.
Since the PPVA owner maintains control and access to the value in the PPVA while they are alive, there is no income-tax deduction on the cash contribution used to fund the PPVA. If a family is willing to part with control of the assets and make the donation to charity during their lifetime, they might instead utilize a financial tool that provides an immediate income tax deduction, such as a CRT or a DAF. Families that use PPVA today generally do so as part of a two-pronged approach: (1) an outright gift, CRT and/or DAF for donations during their lifetime to benefit from the income tax deduction and future income-tax-free appreciation; and (2) a PPVA for charitable bequests at death to benefit from tax-deferred growth of the account value while maintaining control of the assets.
A PPVA differs from a retail variable annuity in that the cost structure is generally lower. A retail variable annuity can have expensive riders, driving the cost upwards of 250 basis points per year and containing large surrender charges for early termination. A PPVA can be structured with a tiered fee schedule and a price cap of 55 basis points for deposits of $5 million, with a lower fee for larger premium deposits. There are no surrender charges or additional PPVA fees.
PPVAs are gaining traction among ultra-affluent families who are incorporating a charity into their estate plan and want the flexibility to change their minds in the future if financial markets don’t cooperate or their desires change. The aforementioned example, in which the widow was able to leave more than $80 million more to charity while retaining control of her assets at her death at age 85, illustrates why a PPVA can be more attractive than making a charitable bequest through a last will and testament.
Matthew Phillips and Jeri Turley are both principals at Winged Keel Group.
The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and are provided with the understanding that Winged Keel Group is not engaged in rendering tax or legal services. A Private Placement Variable Annuity (PPVA) Account is an unregistered securities product and is not subject to the same regulatory requirements as registered products. As such, a PPVA Account should only be presented to accredited investors or qualified purchasers as described by the Securities Act of 1933. Variable annuities are long-term investments designed for retirement. The value of the investment options will fluctuate and, when redeemed, may be worth more or less than the original cost. Withdrawals and other distributions of taxable amounts, including death benefit payments, will be subject to ordinary income tax. If withdrawals and other distributions are taken prior to age 59 1/2 a 10% federal penalty may apply. A withdrawal charge may also apply. Withdrawals will reduce the value of the death benefit and any optional benefits.