The tax benefits of private placement variable annuities for wealthy clients are drawing scrutiny and calls for a federal crackdown — but they're not going away anytime soon.
Deferral or the outright avoidance of taxes on income, capital gains and estates has drawn billions of dollars to private placement life insurance and annuities. The growth of the life insurance product — a similar but more complicated strategy with higher potential savings for clients — amounts to contracts totaling nearly $40 billion in policy value,
"Anything being produced like that is something to be taken seriously," Sam Petrucci, the head of advice, planning and fiduciary services for New York-based Neuberger Berman Private Wealth, said in an interview about
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The annuities work like a "supercharged IRA" for wealthy clients — with some cautions and caveats, Petrucci noted. Financial advisors, tax professionals and their clients should remember that they would need to wait to take any withdrawals from a private placement variable annuity until they're at least 59 ½ years old. They also need to ensure that the savings and duty-free investment gains accumulate for at least a decade or more to reap the advantages of the underlying cost of the annuity.
In the meantime, they can avoid the headache of
That's why they're "something that is being utilized more and more by wealthy taxpayers," Petrucci said. The other strategy, private placement life insurance, comes with "more complexity and cost," he noted.
Petrucci explained the appeal of private placement variable annuities by comparing the limitless contributions to the maximum allowed in IRAs and using an example of a taxable investment that yielded 10% in a year for a client in the wealthiest bracket. If that client lives in a high-tax city and state like New York, the short-term capital gains rate and other duties would leave the customer with about 4.6% of those returns, he said. In a private placement variable annuity, the client can net the 10% return without paying any taxes and let those yields stay in the account to keep building for the long term.
"The problem with your retirement plans is you can only own so much in those respective plans," Petrucci said. "By [using a private placement variable annuity], you're able to increase your return by a substantial amount. This is something that we see great interest in, from an income-tax planning perspective."
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Annuity and
While Wyden described private placement life insurance in a statement as "just a tax shelter for the investments of the mega-rich masquerading as life insurance," the committee's report specifically called out annuities as well in a list of seven principles it said will guide future bills. In addition, the committee vowed to design legislation targeting not only new products after its enactment but the existing policies and contracts already in place, too.
"Legislation must address both private placement life insurance and private placement annuity contracts to prevent high net-worth individuals from merely shifting assets from a private placement life insurance policy to a private placement annuity contract," the report said. "The tax preferences for private placement annuities may not be as lucrative as PPLI but they are still very attractive. Legislation must provide that PPLI and certain annuity contracts will not be treated as life insurance or annuity contracts under federal tax laws, with the resulting effect being that all earnings of the contract will be taxed currently instead of accumulating tax-free."
In its proposal on pages 157-162 of the
"PPLI and PPA [private placement annuity] contracts allow very affluent purchasers to select from an array of investment options that are not accessible generally to purchasers of registered policies," it said. "For example, PPLI and PPA separate accounts may be invested in unregistered hedge funds and private equity funds or in more exclusive portfolios closely tailored to the investment preferences of private placement policyholders (possibly including real estate and other assets deemed attractive to the specific investor). PPLI contracts are highly investment-oriented policies, provide legally minimal life insurance protection relative to the amounts invested, and are available only to the wealthiest taxpayers to whom income tax and/or estate tax benefits are far more important than the provision of insurance for their heirs."
Treasury's proposal would slash the tax advantages by defining contracts "that are predominantly investment oriented and denying these contracts most of the tax benefits that are generally granted to life insurance and annuity contracts."
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The Biden administration's idea would likely garner legal challenges that could prove successful in blocking it on equal-protection grounds, according to an attorney who spoke with the
"Giving a bit of flexibility to the IRS in the statute is important here, because we've seen that these are highly sophisticated taxpayers who have been able to deftly structure and adapt these transactions," he said.
Absent those changes, the private placement variable annuities remain available to advisors and their clients under the existing laws, which allow for removing the assets from a customer's taxable income forever by donating them, Petrucci noted.
"They can also be an effective planning tool if you leave your PPVA structure to charity," he said. "Ultimately, if you leave it to charity, it's entirely tax free."
