Elements of a Private Placement Life Insurance Transaction

November, 2024
Elements of an Insurance Transaction
  1. A policy is issued to the owner from the insurer after underwriting approval of the insured and acceptance by the owner, who then remits premiums to the carrier.  Premium payments can be in the form of cash or in-kind (in-kind premiums such as property or securities in kind are subject to taxation on any gain in value at the transfer from the policyowner to the insurer’s separate policy account).
  2. Owner selects a Separately Managed Account (SMA) or an Insurance Dedicated Fund (IDF) in which the cash value will be invested and managed by a desired Registered Investment Advisor (RIA) or similarly permitted Investment Manager.  The cash value is held in a separate account, segregated from the carrier’s general account assets, dedicated exclusively to the owner’s PPLI policy, and not subject to the reach of the carrier’s general creditors.
  3. The separate account invests the existing cash value and new premium amounts into the SMA or IDF.
  4. Cash is disbursed from the SMA or IDF to the separate account as needed where it may be held in a money market fund for payment of upcoming cost of insurance (COI) charges and other contractually listed policy fees, disbursed to the policy owner if a withdrawal is elected or invested in a fixed account to be held as collateral if a policy loan has been advanced by the insurer to the policy owner.1
  5. Owner has the choice to receive distributions from the separate account cash value in the form of withdrawals and policy loans which, if properly structured, can be income tax free.2
  6. Upon the insured’s death, the insurer will pay the death benefit proceeds, reduced by any prior withdrawals and outstanding policy loans, to the beneficiary designated by the owner which, if properly structured, can be income tax free.3
Diagram of transaction
Tax Attributes of a Private Placement Life Insurance (PPLI) Policy

Under current law, if properly structured, PPLI policies are treated like a traditional policy for tax purposes:

  • Annual income on the policy (excess of the cash surrender value increase plus the cost of life insurance protection over the premiums paid for the taxable year) is not taxable to the owner if the policy meets the definition of life insurance.4
  • Cash value can be distributed to, and without recognition of taxable income by, the policy owner if in the form of withdrawals up to cost basis and/or policy loans, the policy is held in force to the insured’s death, and never becomes a Modified Endowment Contract (MEC).5
  • Death benefit proceeds received by reason of the insured’s death are not includible in the recipient’s gross income if the policy has not been previously transferred for valuable consideration or involved in a transaction that was treated as a reportable policy sale.6

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  1. 1 PPLI carriers typically hold enough value upfront in the money market fund within the separate account to support the deductions for the anticipated policy charges over 12-month periods thereby necessitating a distribution from the SMA or IDF to cover policy charges only once per policy year.  If a policy loan is made to the owner, policy assets may need to be sold in order to provide the insurer with the requisite liquidity to make the loan.
  2. 2 Income tax-free loans available if policy is structured as a non-Modified Endowment Contract.  Access to cash values through borrowing or partial surrenders will reduce the policy's cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.
  3. 3 IRC §101(a)(1)
  4. 4 IRC § 7702.
  5. 5 IRC §§ 72, 7702A.
  6. 6 IRC § 101, Treas. Reg. § 1.101-1.

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