For affluent investors, using hedge funds as investment vehicles can be powerful tools for accumulating and building wealth. However, hedge funds can be extremely tax inefficient because there are often many short-term transactions that are passed on to the investors in the fund. This results in short-term capital gains tax at your ordinary income tax rates (often over 35%!).
Investors who are looking to use hedge funds but don’t like the idea of paying short-term capital gains tax should consider private placement life insurance (PPLI). PPLI is a relatively unknown strategy but is one that can result in dramatic tax savings.
The way it work is PPLI is a variable universal life insurance product designed to hold interests in various assets such as hedge funds, limited partnerships and other alternative investments. By utilizing the insurance structure, PPLI effectively converts a tax-inefficient vehicle into a tax-efficient one.
Similar to cash value life insurance PPLI offers significant advantages. The investments in PPLI will grow and compound tax free and there are ways to withdraw money through policy loans that also avoid any income tax burden. If you keep the policy for your whole life, the proceeds will pass to the next generation income tax-free. Putting the policy in an irrevocable life insurance trust (ILIT – a topic for another day) will also allow you to avoid paying estate taxes.
To summarize the typical benefits of PPLI:
- Tax-advantaged investment platform
- Lower costs than retail insurance products
- No surrender charges often found in retail insurance products
- Simplified tax reporting as you won’t have to report K-1s from the underlying investments
- Avoid phantom income (associated with reported gains that aren’t distributed)
- Estate planning advantages
- Tax-free policy exchanges – meaning you can transfer existing life insurance policies into a PPLI
- Enhanced creditor protection
PPLI is only available to “accredited investors” and “qualified purchasers” as defined by the SEC as those having at least $1 million of net worth (excluding primary residence) and income of at least $200K (or $300K if married filing jointly).
If you know someone who might benefit from discussing a private placement life insurance product, please contact our team and let us know.
All the best,
Your Fortis Capital Management Team