In 1752 when Benjamin Franklin formed The Philadelphia Contributionship, the organization became the first insurance company in the American Colonies. While much has changed over the past 268 years, the Contributionship still remains in business today, and along with it, the concept of transferring “value” in exchange for goods and services.
Since the beginning of 2000, high-net-worth families have worked with the world's leading law firms in developing custom-designed variable universal life insurance policies to provide a more complete life insurance solution for their families (a wide array of benefits to their loved ones) and for charities. These policies have been sold via the use of Regulation D “private placement” documents or “PPMs” for securities law purposes. These customized insurance policies are frequently funded with a combination of cash and certain noncash assets, which can include interests in private equity, real property, hedge funds, artwork, aircraft and qualifying majority-owned entities via in-kind contribution.
Overview of In-Kind Premiums
Many tax and life insurance practitioners are unaware that hard-to-value assets, such as interests in private business entities and real estate holding companies (“non-bankable assets”) or “in-kind” premiums are readily accepted by life insurance companies whose primary market focus is with HNW clients seeking customized client-centric life insurance protection plans. For this reason, advisors and their clients miss a variety of the tax-planning solutions that can lead to greater protection and significantly greater tax-advantaged wealth accumulation over the lifetime of the policyholder.
When it comes to the purchase of life insurance, the term “premium” represents the total amount of fiat currency and other consideration (excluding interest on policy loans) that are paid in exchange for the issuance of a life insurance policy and the policy benefits. These in-kind or noncash premiums become part of the policy’s cash value within the PPVLI policies. These noncash premiums are invested within the policy and receive the same tax treatment as any other types of assets held within any compliant policy, as recently determined under an IRS private letter ruling nonpublished and of no precedential value.
From a tax perspective, it is important that the investment policy statement within the policy’s investment fund that governs the investment holdings within the policy be sufficiently broad, and that no prior agreement (expressed or implied) exists between the policyholder and his or her investment advisor regarding the continued holding of the contributed assets within the policy investment/ cash value account basket. The key metric is valuation and maintenance of a diversified portfolio of policy investments within the meaning of Section 817(h) of the Code and the applicable Treasury Regulations.
The National Association of Insurance Commissioners (NAIC) follows this long-standing acceptance of in-kind assets for both casualty and life insurance policies, and goes even further, avoiding any specifically enumerated definition of premium and in-kind premiums within their publications and issuances of regulatory guidance.
Following the death of an insured, it's common for customized PPLI policies to distribute in-kind holdings from the policy cash value as part of the death benefit's policy death benefits. Once again, there is no prohibition of in-kind death benefits from a life insurance or annuity policy.
Strategy Example
- The Facts
Hector, age 45, is a high-net-worth investor who has invested in a dozen pre-IPO companies. He is married and has three children. The total amount of his investments in the portfolio of privately held companies is $2.5 million. The number of companies in the portfolio is 10. The projected valuation of the portfolio making reasonable assumptions following an initial public offering is $60 million. Hector is a resident of California and is in the top marginal tax bracket for federal and state purposes.
- Solution
Hector establishes a Spousal Lifetime Access Trust (SLAT) with the Nevada Trust Company. The Trustee is the applicant, owner and beneficiary of a PPLI policy issued by Acme Life and Annuity, a Barbados life insurer. Hector funds the Trust using his exemption equivalent for estate and gift tax purposes, transferring the portfolio to the trust. The policy features a customized investment account managed by Good Investments LLC.
The trustee transfers the portfolio as an in-kind premium based upon an independent valuation. The transfer to Acme Life is treated as a sale or exchange for tax purposes. Any gain is triggered and taxable to the grantor since the trust is a grantor trust for tax purposes. Under the terms of the investment advisory agreement, Good Investments has the legal discretion to buy and sell investments within the policy. Hector and the IDF manager develop a broad investment policy that comports with Hector’s risk level, timing and planning objectives. The IDF manager controls Good Investments’ investment discretion under the investment policy. Hector has no ability to control Good Investments’ investment discretion.
The PPLI marketplace offers HNW investors flexibility and customization that is absent in the retail life insurance market. PPLI is a product offering that features investment customization and institutional pricing. The flexibility to make in-kind premiums is an additional feature that does not exist in the retail life insurance. This planning feature allows a prospective policyholder with the ability to fund a policy with a low basis capital asset that has the potential for substantial capital appreciation within the tax advantaged environment of a PPLI contract. This flexibility should cause HNW investors to evaluate and reconsider their existing life insurance and investment tax planning. Sometimes mixing metaphors, life insurance and tax planning, can be a good thing!
Steven Horowitz is the managing partner of Horowitz & Rubenstein. Gery Nowotny is principal of Gerald Nowotny PLLC and is of counsel to Horowitz & Rubenstein. Brad Barros is the president & CEO of Private Risk Capital Development Advisors LLC.