An easy way to maximize your investment income
BY IRVING L. BLACKMAN, CPA
Tax, succession specialist
This article continues my quest to lead the education parade for my readers in the areas of “How to make it” and “How to keep it.” Today’s subject matter — a little-known strategy — goes to the head of the class not only as a star income tax saver, but also an estate tax destroyer and a superior asset protection device.
Yes, there is a single strategy that does all three. What is it? Private placement life insurance (ppli). If you are fortunate enough to consider yourself an affluent individual, you’ll love every word you are about to read.
Who falls into the affluent category? Well, the most recent IRS data available (for 2007) shows the top 1% of taxpayers (earning $410,000 or higher) paid a whopping 40.4% of all federal income taxes. Astounding — because those taxpayers made only 22.8% of the reported adjusted gross income for 2007.
In my book, this 1% group really deserves a tax break. Note: Now more than ever, because the elected Washington geniuses are a sure bet to raise the income tax rates on upper income earners.
Now, what is ppli? It is a form of variable universal life insurance that is offered privately, rather than through a public offering. Variable life insurance has cash value that is dependent on the performance of one or more investment accounts in the policy. Since the insurance company cannot know the specific investment goals of each traditional policy purchaser, the carrier often settles for registering a set offering, including a selection of mutual funds or hedge funds as investment options within the policy. On the other hand, the carrier customizes the investment options to meet the needs of each ppli owner/investor.
The prime purpose of ppli is to make your investment profits (whether capital gains, dividend income or interest income) tax-free. Simply put, all policy investments are wrapped in a tax-free insurance envelope.
Just how significant are the wealth accumulation results of taxable vs. tax-free? An example is the easiest way to grasp the difference. The following example (created by Lewis Schiff, an Austin, Texas, lawyer) will astound you.
Facts: For example, take a ppli policy insurer who is a 45-year-old male paying $2.5 million in premiums for 5 years ( a total of $12.5 million). The assumed rate of return is 10% (net of investment-management fees), taxed as ordinary income (at 40%, including Federal and State taxes).
Results: in $ millions (rounded):
Two huge advantages pop out:
- The death benefit is always king
- In the long-run, use every opportunity (notice the huge higher amount in cash value after 20 years compared to taxable investment) available to get into an income tax-free environment. Neither the “cash value increases” nor the “death benefit” is subject to income tax.
Note: ppli premiums:
- Start from a low of $1 million (for example, $250,000 per year paid over four years)
- Reach a more typical $5- to $10-million or more (paid in the early years)
- Can be large ($5 million or more) paid as a single premium at inception. Yes, $50 to $100 million polices can be arranged.
Now let’s look at a three-step example (courtesy of Donald D. Cameron, clu, a long-time ppli guru) who uses ppli to create an effective private retirement plan.
Facts: A 50-year old male, non-smoker, with cash value compounding at a 10% annual rate (after investment management fees).
Step #1. Pays a $1 million premium for a ppli for 5 years — total premium of $5 million.
Results: Step #2. After 15 years (age 65) receives $1,213,538 per year for life.
Step 3. After 50 years (age 100) $9,856,418 is payable as a death benefit. (Payments in Steps 2 and 3 are income tax-free.)
Let’s take a look at some other advantages of ppli:
- Liquidity. When needed, you can borrow a portion of the “cash value,” which can be paid back at any time or out of the “death benefit.”
- Asset protection. Your investments are placed in separate accounts, avoiding any risk of insurance company illiquidity.
- Risk minimization. Insurance is a risk-shifting strategy in the event of a premature death, always supplementing the tax-free investment results (at any age).
- Estate tax free. The ppli arrangement can be set up so the ultimate death benefit is not subject to estate taxes.
- Investment flexibility. You can, with the help of the insurance company, if desired, select from a large number of hedge funds. Or work with a third-party advisor (whom you select). Can even switch advisors or have more than one. Also permissible to invest in a private equity deal (maybe one of your own companies or someone else’s) that you think has great upside potential.
- Low investment cost. Traditional agent’s commissions are eliminated, letting more funds “work” inside your policy. True “no-load” insurance. Typically, ppli is placed with an offshore insurance company, further reducing the policy costs. Also, there are no surrender charges or other insurance company penalties.
What if your health or age prevents you from getting insurance, including ppli? Then you can purchase a private placement deferred variable annuity (ppdva). This type of annuity is similar to a ppli, except the income is deferred until the policy owner takes a distribution (taxable at ordinary income tax rates).
If you have a large investment portfolio, whether cds, municipal bonds, hedge funds, stocks or bonds, or any of the other endless parade of investment vehicles, then ppli is something you should look at. Your investment wealth is sure to compound at an accelerated pace because you won’t lose one cent in income taxes.
You’re sure to have questions. Just call me (847/674-5295) to discuss how a ppli or ppdva can be designed just for you.
Irv Blackman, cpa and lawyer, is a retired founding partner of Blackman Kallick Bartelstein, llp (cpas) and Chairman Emeritus of the New Century Bank (both in Chicago). Want to consult? Need a second opinion?.Contact Irv by phone at 847/674-5295, e-mail blackman@estatetaxsecrets.com or visit his website at www.taxsecretsofthewealthy.com.