PORTFOLIO

Private Placement Life Insurance and Annuities (Portfolio 870)

Tax Management Portfolio, Private Placement Life Insurance and Annuities, No. 870, discusses private placement life insurance (PPLI, also known as private placement variable life insurance) and private placement variable annuities (PPVA) and the use of these strategies as investment, income tax, estate planning, asset protection, and philanthropic tools in the high-net-worth marketplace.

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DESCRIPTION

Tax Management Portfolio, Private Placement Life Insurance and Annuities, No. 870, discusses private placement life insurance (PPLI, also known as private placement variable life insurance) and private placement variable annuities (PPVA) and the use of these strategies as investment, income tax, estate planning, asset protection, and philanthropic tools in the high-net-worth marketplace.
This Portfolio examines PPLI and PPVA, two core planning strategies that allow holistic advisors to address a wide variety of client needs:
 I. As investment tools, both PPLI and PPVA enable access to sophisticated investment strategies used regularly by high-net-worth investors.
 II. As an income tax planning tool, PPLI reduces income tax liability as it permits such investments to grow income tax-free.
 III. As an estate planning tool, PPLI has multiple applications that mitigate estate tax liabilities and facilitate the orderly disposition of assets at death. In contrast, PPVA is designed to supplement the client's estate during life.
 IV. As asset protection vehicles, both PPLI and PPVA offer both financial privacy and, in some cases, significant protection from future creditors.
 V. As augmentation to philanthropic goals, both PPLI and PPVA represent powerful tools that leverage charitable giving.
Further, this Portfolio will examine all of the tax, legal, and technical considerations associated with PPLI and PPVA, including considerations regarding domestic versus international carriers as well as the associated tax reporting.
For a discussion on commercial annuities, life insurance, and long-term care insurance products, see 546 T.M. Annuities, Life Insurance, and Long-Term Care Insurance Products (U.S. Income Series).
This Portfolio may be cited as Giordani and Chesner, 870 T.M., Private Placement Life Insurance and Annuities.


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AUTHORS

LESLIE C. GIORDANI, ESQ.
Ms. Giordani and Mr. Chesner are with the Austin, Texas law firm of Giordani, Swanger, Ripp & Phillips, LLP, a boutique provider of estate planning, tax, business planning and insurance advisory services to high-net-worth and financial industry clientele. Ms. Giordani is a partner in the firm and has over 20 years' experience as an estate planner, is board certified in estate planning and probate by the Texas Board of Legal Specialization, is a fellow of the American College of Trust and Estate Counsel, and has been recognized in Best Lawyers in America for more than 10 years.

ROBERT W. CHESNER, JR.
 Mr. Chesner is a director in the firm where he manages its insurance practice, and has over twenty years' experience as a high-ranking insurance executive in the insurance industry.

TABLE OF CONTENTS

Portfolio 870-1st: Private Placement Life Insurance and Annuities

Portfolio Description

Authors

Technical Advisors

Description

Detailed Analysis

I. Introduction to Private Placement Life Insurance and Annuities

A. A Tax, Estate, and Investment Planning Tool with Multiple Applications

B. An Alternative to Structured Products

C. Overview of the Marketplace

1. Carriers

2. Investment Managers

3. Insurance Brokers and/or Fee-Based Advisors

4. Legal Advisors

II. Tax, Legal, and Technical Considerations

A. Life Insurance and Annuity Terminology

1. Life Insurance

a. Accumulation Value

b. Cash Surrender Value

c. Death Benefit

d. Segregated Asset Account

e. Insured

f. Policy Owner

g. Beneficiary

2. Annuities

a. Annuitant

b. Contract Owner

c. Segregated Asset Account

d. Beneficiary

e. Annuitization

B. Types of Life Insurance and Annuities

1. Life Insurance

a. Term Insurance

b. Whole Life Insurance

c. Variable Life Insurance

d. Universal Life Insurance

e. Variable Universal Life Insurance

f. Private Placement Variable Life Insurance

2. Annuities

a. Immediate Fixed Annuities

b. Deferred Fixed Annuities

c. Immediate and Deferred Variable Annuities

d. Private Placement Variable Annuities

C. U.S. Tax Treatment of Life Insurance

1. Qualifying as a Life Insurance Contract

a. Section 7702: Life Insurance Contract Defined — Cash Value Accumulation Test

b. Section 7702: Life Insurance Contract Defined — Guideline Premium Test and Cash Value Corridor Test

2. Section 7702A: Non-MEC vs. MEC

a. 7-pay Test

b. Treatment of Material Changes

3. Section 817: Special Rules for Variable Contracts

a. Diversification

(1) Test

(2) Timing

(3) Grace Period

(4) “Market Fluctuations” Rule

(5) Treatment of Funds

(a) Insurance Dedicated Funds

(b) Non-Insurance Dedicated Funds

(6) Treatment of Bonds

(a) Single Issuer Rule

(b) Special Exception for U.S. Treasury Securities

b. Investor Control

(1) Investor Control Doctrine History

(a) Christoffersen v. United States Upheld Rev. Rul. 81-225

(b) Enactment of § 817

(2) Insurance-Dedicated Funds

(a) Definition

(b) Double Look-Through Allowed for Second Tier IDFs

(c) IDFs may Invest in Non-IDFs

(d) Multi-Series Insurance Dedicated Fund

(e) Can Foreign Insurance Companies Invest in IDFs?

(3) Managed Separate Accounts

(a) Definition

(b) Managed Separate Account Validity

(c) Rev. Rul. 2003-91 and Related Rulings

(d) Types of Managed Separate Account Structures

(e) Directly Managed Separate Account

(f) Carrier LLC Managed Separate Account

(g) Internal Legal Memorandum 200840043

(h) Commingled vs. Non-Commingled Managed Separate Accounts

4. Income Tax Rules Applicable to U.S. Taxpayers Who Own Life Insurance Policies

a. Non-Taxation of Internal Build-Up

b. Distributions During Policy Term

(1) Non-Modified Endowment Contract Distributions

(2) Modified Endowment Contract Distributions

c. Surrender or Maturity of Policy

d. Policy Proceeds

e. Transfer for Value Rule

f. Section 4371: Excise Tax on Life Insurance Premiums Paid to Foreign Insurers

g. Section 1035: Tax-Free Exchange

5. Transfer Tax Rules Applicable to U.S. Taxpayers Who Own Life Insurance Policies

a. Section 2042

b. Section 2035(a): The Three-year Rule

6. Income Tax Rules Applicable to Non-U.S. Taxpayers Who Own Life Insurance Policies

a. Generally Similar to Rules for U.S. Taxpayers

b. Taxable Amounts Subject to Withholding

7. Transfer Tax Rules Applicable to Non-U.S. Taxpayers Who Own Life Insurance Policies

a. Introduction

b. Section 2105

D. U.S. State Tax Treatment of Life Insurance Premium Payments

1. Premium Tax Regimes

2. Direct Procurement Statutes

a. In General

b. Modern Trends of Direct Procurement Taxes

3. State Premium Tax

E. U.S. Tax Treatment of Annuities

1. Qualifying as an Annuity

a. Section 72: Annuity Contract Defined

b. Annuity Rules Applicable to Certain Proceeds of Endowment and Life Insurance Contracts

2. Income Tax Rules Applicable to U.S. Taxpayers Who Own Annuities

a. Tax During Accumulation Period

b. Tax During Annuitization Period

c. Income in Respect of a Decedent

d. Section 1035: Tax-Free Exchange

3. Transfer Tax Rules Applicable to U.S. Taxpayers Who Own Annuities

4. Income Tax Rules Applicable to Non-U.S. Taxpayers Who Own Annuities

a. Generally Similar to Rules for U.S. Taxpayers

b. Withholding

c. U.S. Issued vs. Non-U.S. Issued Private Placement Variable Annuity Contracts: Original Issue Discount Problem

5. Transfer Tax Rules Applicable to Non-U.S. Taxpayers Who Own Annuities: U.S. Situs vs. Non-U.S. Situs

F. Tax Analysis: Life Insurance vs. Annuity

G. U.S. Securities Treatment of PPLI and PPVA

1. Qualified Purchaser

2. Accredited Investor

3. Special Considerations for Offshore Policies

H. Domestic vs. Offshore PPLI

1. In General

2. Carrier Considerations

a. Ratings

b. Actuarial Support

c. Administrative Capability

d. Capital and Surplus

e. Adding Investment Options

(1) PFIC Issues

(2) Investment in IDF by Foreign Carriers

f. Commitment to Marketplace

g. Separate Account Protection

(1) Off Balance Sheet Accounts

(2) General Account Exposure

h. Selection of Jurisdiction

3. State Premium Tax Applicability

4. DAC Tax vs. Excise Tax

5. Statutory Asset Protection

a. Overview

b. Bermuda

c. Cayman Islands

6. Insurable Interest Considerations

a. Domestic Insurable Interest Issues

b. Offshore Insurable Interest Issues Generally

c. Insurable Interest Issues Related to Stranger- Originated Life Insurance

7. State Law Solicitation Rules and Their Impact on Offshore PPLI

I. Policy Funding and Financial Projections

1. Life Insurance

a. Non-MEC Financial Projections

b. MEC Financial Projections

2. PPVA Financial Projections

J. Product Design

1. Maximization of Cash Value vs. Death Benefit

2. Insured Lives

a. Single Life

b. Joint and Survivor

3. Policy Loan Provisions

a. In General

b. Mechanics of a Loan

4. Extended Maturity Option

5. Parent Guarantees and Cut-Through Agreements

6. Death Benefit Payout Provisions

7. Force-Out Provisions

K. Fees and Expenses

1. Overview

2. Insurance Company Fees: PPLI

a. Premium Loads

(1) Premium Tax

(2) DAC Charge

(3) Possibility of Amortization

b. Mortality and Expense Charge

c. Cost of Insurance Charge

d. Surrender Fees

3. Insurance Company Fees: PPVA

a. Mortality and Expense Charge

(1) DAC Charge

(2) State Premium Tax

b. Surrender Fees

4. Agent/Broker Fees/Compensation

5. Investment-Related Fees

a. Investment Management

b. Investment Consulting

6. Legal, Accounting, and Advisory Fees

a. Legal

b. Accounting

L. Underwriting

1. Overview

2. Medical Underwriting

3. Role of the Direct Insurer, the Reinsurer, and Retrocessionnaires

4. Automatic vs. Facultative Reinsurance

5. Financial

a. Typical Requirements

b. Financial Privacy Considerations

6. Role of the Agent/Broker

M. Policy Servicing

1. In General

2. Required Elements of Service

a. Reporting

b. In-Force Illustrations

c. Force-Out Prevention

d. Ongoing Manager and Carrier Due Diligence

e. Annual Reviews

f. Premium, Loan, and Death Benefit Processing

g. Communication with Policy Owner

III. Investment Considerations

A. Private Placement Life Insurance as an Investment Tool — Overview

B. Private Placement Life Insurance's Relationship with Hedge Funds

1. The Use of Hedge Funds

2. Tax and Administrative Issues with Hedge Funds

a. Absence of K-1 Reporting

b. Valuation and Liquidity

(1) In General

(2) Lock-Ups

(3) Gates

(4) Hold-backs

(5) Side Pockets

3. Coordination with PPLI and PPVA Products

IV. Planning Applications

A. Planning for the U.S. Taxpayer

1. Individual Ownership of Policy

a. Tax Considerations

(1) Income Tax and Compliance Planning

(2) Retirement Income Planning

(3) Federal Estate Tax Issues

b. Asset Protection Considerations

(1) Domestic

(2) Offshore

2. Grantor Trust Ownership of Policy (Incomplete Gift)

a. Domestic

b. Offshore Asset Protection Trust

(1) Counterargument to Fraudulent Transfer

(2) Tax Compliance and Administration

3. Irrevocable Life Insurance Trust Ownership of Policy

a. Exemption Planning

b. Gift Tax Arbitrage

c. Private Split-Dollar Funding

(1) Special Considerations for Offshore Irrevocable Life Insurance Trusts (ILIT)

(a) In General

(b) Section 684

(2) Section 7701(a)(31)

4. “Dynasty” or Other Exempt Asset Trust Ownership of Policy

5. Family Limited Partnership or Other Leveraged Gifting Vehicle Ownership of Policy

6. Co-Ownership Planning

7. Charitable Structure Ownership of Policy

a. Charitable Lead Trusts and Charitable Remainder Trusts

b. Private Foundations

c. Charitable Split-Dollar

B. Planning for Foreign Trusts with U.S. Beneficiaries

1. Federal Income Tax Treatment of Nonresident Aliens Generally

2. What Is a Foreign Nongrantor Trust?

3. Background: Pre-1996 Tax Framework

4. Post-1996 Tax Framework

5. Tax Consequences of Foreign Grantor Trusts

a. Income Taxed to Grantor

b. Classification of a Foreign Trust as a Grantor Trust — General Rule

c. Exceptions to General Rule

d. U.S. Beneficiary

6. Tax Consequences of Foreign Nongrantor Trust

a. Distributable Net Income (DNI)

b. Undistributed Net Income (UNI)

c. Accumulation Distributions

7. PPLI as a Solution to the Accumulation Distribution Problem

a. Modified Endowment Contract (MEC)

b. Non-MEC

C. Pre-Immigration Planning

D. Planning for Foreign Persons Residing Temporarily in the United States

V. U.S. Tax Reporting Requirements for PPLI Policies with Foreign Structures

A. Overview

B. Foreign Trust-Related Filings

1. Settlor/Grantor

a. Form 3520 — Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts

b. Form 709 — U.S. Gift (and Generation-Skipping Transfer) Tax Return

2. Trustee

a. Form 3520-A — Annual Information Return of Foreign Trust with a U.S. Owner

b. Foreign Grantor Trust Owner Statement

c. Foreign Grantor or Nongrantor Trust Beneficiary Statement

d. Appointment of U.S. Agent for Tax Reporting Purposes

e. Form 1041 — U.S. Income Tax Return for Estates and Trusts

f. Form 1040NR — U.S. Nonresident Alien Income Tax Return

3. Beneficiaries

a. Form 3520 — Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts

b. Form 4970 — Tax on Accumulation Distribution of Trusts

C. Filing Requirements Related to U.S. Owned Foreign Partnerships and Disregarded Entities

1. Form 8832 — Entity Classification Election

2. Form 8858 — Information Return of U.S. Persons With Respect to Foreign Disregarded Entities

3. Form 8865 — Return of U.S. Persons with Respect to Certain Foreign Partnerships

4. Form 1065 — U.S. Partnership Return of Income

5. Form 8938 — Statement of Specified Foreign Financial Assets

D. Disclosure of Foreign Financial Accounts — FBAR


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Commissioners 2001 Standard Ordinary Mortality Table

Worksheet 2 Sample Private Placement Life Insurance and Taxable Investment Illustrations: Offshore and Domestic

Worksheet 3 Sample Private Placement Life Insurance Policy Contract

Worksheet 4 Sample Private Placement Memorandum

Worksheet 5 Sample Private Placement Life Insurance Application

Worksheet 6 Sample Private Placement Life Insurance Investment Election Form

Worksheet 7 Private Placement Life Insurance Underwriting Questionnaire

Worksheet 8 Private Placement Life Insurance Questions and Answers

Worksheet 9 Private Placement Life Insurance Ownership Charts

Worksheet 10 Split-Dollar Agreement for Use with Private Placement Life Insurance

Worksheet 11 Collateral Assignment for Split-Dollar Agreement for Use with Private Placement Life Insurance

Worksheet 12 Split-Dollar Mechanics for Private Placement Life Insurance

Worksheet 13 Fact Pattern and Sample Completed IRS Forms for Ownership of Private Placement Life Insurance Through Foreign Structure (Forms TDF 90-22.1, 709 Attachment, 720, 3520, 3520-A, 8832, 8858, 8865)

Bibliography

Books

Bulletins and Newsletters

Seminars

Periodicals

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