Traditional cash value life insurance often is used as part of

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1 Reproduced by permission Colorado Bar Association, 41 The Colorado Lawyer 85 (July 2012). All rights reserved. TAX LAW Customized Private Placement Life Insurance: An Asset Protection and Investment Tool by Alan R. Jahde This article explains how customized private placement life insurance can provide significant investment and tax benefits for high-net-worth clients when used as an estate planning and asset protection tool. Traditional cash value life insurance often is used as part of an estate plan solving an insurance need, such as providing liquidity to the decedent-insured s estate through a death benefit to his or her family. Over the last twenty years, a new life insurance product private placement life insurance (PPLI) has been offered by onshore and offshore carriers. PPLI is a specialized form of variable life insurance that is not registered by the U.S. Securities and Exchange Commission (SEC) and is available to high-net-worth clients. When purchasing traditional cash value life insurance, the purchaser may pay less attention to the investment return of the cash value portion of the life insurance policy than to the death benefit. In contrast, the purchaser of PPLI generally has two goals: meeting an insurance need for death benefit protection, and accumulation through increased buildup of the inside cash value. As an investment tool, PPLI can hold a variety of investments, such as stocks, bonds, hedge funds, and other private equity investments that, over time, will enhance the policy owner s accumulation goal. 1 When fully compliant with all applicable tax laws, life insurance (including PPLI) receives advantageous tax treatment, which allows policy investments to grow free of income tax and, with proper estate planning, to pass to beneficiaries free of estate tax on the insured s death. 2 Life insurance also may be owned by certain vehicles, such as trusts or limited liability companies, which can offer significant asset protection to the policy assets. The combination of several features makes customized PPLI particularly well-suited to achieving the investment, estate planning, and asset protection goals of high-net-worth clients: 1) advantageous income and estate tax treatment; 2) focus on accumulation and growth; 3) nontaxable access to cash value during one s lifetime; 4) asset protection options; and 5) meeting an insurance need of providing liquidity to the policy owner s estate. This article explores how advisors and clients can use customized PPLI to meet these goals. PPLI and Customized PPLI PPLI is a specialized type of cash value variable universal life insurance. 3 PPLI policies must fully satisfy the requirements for life insurance under the Internal Revenue Code (Code). 4 PPLI policies differ from traditional non-ppli cash value life insurance policies because they are specialized and offer more customizable features. These features include negotiated (and often reduced) fees, a customized death benefit, and selection of either a modified endowment contract or non-modified endowment contract, as described below. Certain insurers permit policy owners to further customize PPLI policies to meet their objectives. Such customized PPLI policies may be referred to as customized PPLI or custom-designed life insurance policies. Although they once required a premium investment of at least $25 million, PPLI policies now are available to customers willing to make a total premium commitment of at least $1 million. 5 Policies may be purchased from either domestic or foreign insurers. Domestic insurers are subject to SEC regulations, which require purchasers of domestic PPLI policies to be accredited investors and generally to also be qualified investors. 6 In effect, purchasers must have annual income of at least $200,000 and minimum net worth of $5 million. 7 Coordinating Editors Adam Cohen, Denver, of Holland & Hart LLP (303) , [email protected]; Steven Weiser, Denver, of Foster Graham Milstein & Calisher, LLP (303) , [email protected] About the Author Alan R. Jahde is a co-founder of Anderson & Jahde, P.C., a Littleton tax law firm that focuses on tax litigation and controversy, income and estate tax planning, asset protection planning, domestic and offshore private placement life insurance planning, and defined benefit pension planning. He thanks Erin Stearns for her contributions to this article. Tax Law articles are sponsored by the CBA Taxation Law Section to provide timely updates and practical advice on federal, state, and local tax matters of interest to Colorado practitioners. The Colorado Lawyer July 2012 Vol. 41, No. 7 85

2 General Taxation Effects and Benefits of Life Insurance Life insurance policies have several tax benefits. These are discussed below. No Income Taxation Earnings on a policy s cash value, including interest, dividends, and capital gains, generally are not taxable to the policy owner as they accumulate within the policy. 8 This tax-free growth environment permits income to accumulate at a higher rate than if the assets were held in a taxable portfolio outside a policy. If a policy is classified as a non-modified endowment contract, as described in more detail below, any withdrawals by the policy owner up to the amount of premiums paid before the death of the insured will not be subject to income tax. 9 To ensure that the policy retains its status as life insurance and that policy earnings will not be subject to income taxation to the policy owner, policy investments must not be subject to any level of investor control by the policy owner. 10 This means the policy owner cannot have any control over the specific selection or retention of policy investments. 11 No Estate Taxation With Proper Estate Planning Policy ownership may be structured so that death benefits are excluded from the taxable estate of the insured and/or policy owner. 12 To avoid estate tax inclusion, policy proceeds cannot be paid to the executor of the insured s estate. 13 The insured also must not retain any incidents of ownership over the policy. 14 In addition, contributions to the policy made within three years of death are subject to estate tax inclusion. 15 No Beneficiary Taxation Life insurance proceeds payable to beneficiaries on the death of the insured generally are excluded from the beneficiaries taxable income for federal tax purposes. 16 These proceeds also pass free of any capital gains taxation. 17 Basic Terminology of Life Insurance A basic understanding of life insurance terminology is important. Some terms are defined below. Cash value: Cash value is the balance of an account maintained by the insurer equaling the sum of life insurance premiums paid plus investment earnings, less policy expenses, reinsurance costs, partial surrenders, and loans. Death benefit: This is the amount paid by the insurance company on the death of the insured. Depending on policy design, the death benefit may be a set amount or an amount that, after the end of seven years, decreases as a multiple of cash value based on the age of the insured. 18 Modified endowment contract (MEC) versus non-modified endowment contract (non-mec): A life insurance contract is categorized as either a MEC or a non-mec, depending on whether it satisfies the criteria of Code 7702A. 19 Withdrawals from a MEC policy are included in the policy owner s gross income and are taxed at ordinary income tax rates to the extent of policy earnings. 20 Withdrawals from MECs also may be subject to an additional 10% penalty tax. 21 If a policy is a non-mec, no penalties or taxes apply to withdrawals up to the amount of premiums paid. 22 Although non-mec classification often is preferable to MEC classification, the distinction matters only if the policy owner will withdraw funds from the policy during the insured s lifetime. If the policy owner intends not to withdraw funds from the policy during lifetime and the primary purpose of the policy is to pass wealth from one generation to the next, MEC status may be preferable, because the overall cost of insurance will be less. 23 Net amount at risk (NAR): This is the amount of actual risk borne by the insurer. It equals the difference between the death benefit and the cash value of the policy. 24 Most insurers reinsure some or all of the NAR. 25 Mortality and expense (M&E) charges: This is an expense charged by the insurer to cover its operating costs and still yield a profit. 26 An annual charge of between 40 basis points (0.40%) and 125 basis points (1.25%) of cash value generally applies to small and medium-sized policies after the policy is fully funded. 27 M&E charges often decrease as policy size increases. 28 Cost of insurance (COI): COI charges are determined based on assumptions made by the insurer about the insured s age, sex, and health status. 29 COI charges may change over time, depending on the assumptions of the insurer and the NAR. COI charges are deducted from the cash value of a policy and are assessed in conjunction with M&E charges. Typical annual COI charges for PPLI policies range between approximately 25 basis points (0.25%) and 50 basis points (0.50%) of the cash value for a single life product (sometimes slightly less for a second-to-die contract) once all premiums have been paid. 30 Total M&E and COI charges for small to medium PPLI policies typically are between 80 and 150 basis points (0.8% and 1.5% of cash value). 31 Surrender fees: These are charged by some insurers on surrender of the policy, when premium payments have not been made, or when the policy owner cashes in the policy. They are assessed against the policy s cash value. Surrender fees charged by domestic insurers of traditional life insurance policies often are explained as being needed to recoup unrecovered sales commissions and for reimbursement of costs of maintaining such policies. 32 Most insurers that pay commissions to an agent selling their policies deduct the commission from the cash value up front. 33 Surrender fees are uncommon with PPLI. 34 Other fees and charges: Other fees include premium loads, asset management, and custody fees. 35 These fees are charged by the insurer, and generally are negotiable in PPLI policies. 36 Fees for asset management and custody services generally are paid directly from the investment account by its custodian. 37 Segregated accounts: A segregated or separate account is a statutory provision that protects the funds of a life insurance policy from being subject to the claims of the insurer s creditors. Foreign jurisdictions, such as Bermuda and the Cayman Islands, have segregated account legislation, and some foreign insurers take the additional step of not commingling policy funds by creating separate bank and brokerage accounts for each policy. 38 The effect of using segregated account legislation and separate bank/brokerage accounts is two-fold: to statutorily protect the cash value of a policy from the creditors of the insurer and claims of other policy holders, and to avoid commingling funds so that the insurer does not use funds of one policy to satisfy policy claims for its other insureds. 86 The Colorado Lawyer July 2012 Vol. 41, No. 7

3 In practice, most domestic insurers of variable life insurance policies have some degree of separate account protection by providing separate statements for each policy account, even if they commingle bank and brokerage accounts for multiple policies. Such accounting is sufficient to protect the cash value of a policy from the creditors of the insurer and claims of other policy holders, but does not ensure that the insurer will not use funds of one policy to satisfy policy claims for its other insureds. 39 Irrevocable life insurance trust (ILIT): An ILIT is a commonly used estate planning vehicle. The grantor/insured creates an ILIT and contributes either an existing life insurance policy or funds sufficient to enable the trustee to purchase a new life insurance policy on the life of the grantor. 40 On the grantor/insured s death, the policy pays proceeds to the trustee, providing liquidity to pay estate taxes. The balance of proceeds, after payment of estate taxes, is distributed to the ILIT beneficiaries, who generally are the grantor s family, in a manner determined by the ILIT s terms. 41 If the ILIT is properly drafted, the proceeds it receives will be excluded from the grantor s gross estate for federal estate tax purposes. 42 The tax advantages of using an ILIT as the designated beneficiary include ensuring that: (1) liquid funds will be available to pay estate taxes on the insured s death; (2) the income and transfer tax liability is minimized and possibly eliminated; and (3) the generation-skipping transfer (GST) tax exemption can be properly allocated. 43 Potential Benefits of PPLI As previously noted, PPLI policies may contain a variety of investments. 44 Because policy owners may pay premiums into a policy as quickly as permitted by the Code and policy design, the cash value portfolio may be fully invested early in the life of the policy. 45 As a result, the policy investments may experience more appreciation and income generation than if premiums were paid in more slowly over the life of the policy. PPLI policies tend to have significantly lower premium loads than traditional non-ppli policies. Typically, they are approximately 1% of the total premium commitment. 46 Features of a Good PPLI Contract It is important to consider the features of a PPLI policy. A good policy might include the features discussed below. Segregated Accounts As noted earlier, segregated accounts (either required under applicable law or offered by the insurer) protect the cash value of each policy from any claims of creditors of the insurer or its other insureds. 47 Because the use of segregated accounts is not required by all insurers, prospective purchasers of PPLI policies should ensure that their policy investments are held in segregated accounts. Transparency Illustrations and ledgers for PPLI policies tend to be more transparent than for traditional cash value life insurance. 48 This transparency enables clients and their advisors to ensure that a PPLI policy will meet client objectives for investment, estate planning, and asset protection. Open and transparent review of all fees, costs, mortality expenses, and loads permits proper evaluation of The Colorado Lawyer July 2012 Vol. 41, No. 7 87

4 the performance of a PPLI contract. It also permits comparison of PPLI to alternative non-insurance investments that provide no death benefit and may be subject to current income taxes on earnings. Transparency encourages discussion of policy design options to attempt to maximize cash value, and promotes trust between the insurer and the client. Custom-Designed Contracts Some life insurance companies can customize PPLI policies, resulting in more individually tailored PPLI policy provisions than are found in static off-the-shelf products. For example, some insurers will offer customized contract provisions for death benefit amounts and duration, funding options, borrowing interest rates, crediting of interest charges, fees and loads, choices of insureds, ownership options, access to cash value alternatives, and use of professional asset managers. Professional Management of Assets The insurance company is responsible for conducting due diligence on and for hiring (or firing) professional asset managers. Using professional asset managers may result in better-performing portfolios than can be achieved or obtained by the general investing public. 49 Professional asset managers often manage policy assets via grantor trusts, partnerships, or insurance dedicated funds (IDFs). 50 Investments Held in IDFs The U.S. Treasury Regulations allow partnerships owned exclusively by insurance companies to look through to their underlying holdings for purposes of meeting the diversification test. 51 By analogy to the diversification testing rules, the IRS has taken the position that if a PPLI policy owns a grantor trust or partnership, the policy funds are not available to the public and such entities are treated as IDFs. 52 Although it has drawn considerable criticism, the IRS takes the position that the investor control rule is violated when a policy owner may choose policy investments that are not held in an IDF (and are available to the public), but is not violated when a policy owner may choose from an insurer-provided list of investments that are held in an IDF (and thus, unavailable to the public). 53 Managed Death Benefit A managed death benefit may be the bare minimum allowed under the Code, a higher amount for a specified time to cover an increased insurance need, or an amount significantly reduced through restricted access to the cash value in the initial years of the contract. Such customization planning can reduce mortality costs and promote policy investment accumulation, or can provide access to life insurance to those with insurability or health issues. 54 No Surrender Fees If a PPLI policy owner is unhappy with the insurer, the performance of the contract, or no longer needs life insurance, contracts may be designed to permit full or partial surrender of the policy without any surrender fees. 55 On surrender of the policy, the owner would receive its cash value. Guaranteed Costs All costs relating to the life insurance contract should be defined, transparent, scheduled, and guaranteed by the carrier for the life of the insured. This includes COI and M&E costs. Interest Paid on Loans Benefits the Contract s Segregated Account PPLI policy terms may be designed and negotiated to permit the policy owner to borrow funds from the policy during the life of the insured. 56 This borrowing is a non-taxable transaction if the policy is designed as a non-mec and no income will be realized or recognized, and no penalties will apply. 57 The policy s cash value increases when the loans are repaid with interest, assuming the life contract provisions require that interest inure to the benefit of the policy s segregated account rather than to the insurer. This removes 88 The Colorado Lawyer July 2012 Vol. 41, No. 7

5 interest payments from the estate, potentially reducing the size of the taxable estate and increasing the size of the policy s cash value without incurring gift taxes. 58 Offshore Versus Domestic Issuers PPLI policies may be purchased from either offshore or domestic insurers. There are advantages and disadvantages to each. Some advantages of offshore PPLI include: Segregated account legislation. Offshore jurisdictions often have segregated account legislation protecting policy assets from the claims of the insurer s creditors. 59 More investment options. Offshore companies generally offer a wider range of investment options than domestic products, because they have access to foreign securities and funds that are off-limits to U.S. investors. 60 Lower tax, maintenance, and overall costs. Offshore policies generally are not subject to state premium taxes, which may be as high as 4% of premiums paid. 61 They may, however, be subject to a 1% excise tax on any life insurance sales to U.S. citizens or residents. 62 Some offshore carriers impose lower M&E, COI, and other premium loads and fees than domestic carriers through reduced costs of complying with one offshore regulator rather than fifty state regulators. 63 Inaccessibility of assets. Practically speaking, assets held in an offshore PPLI contract may be more difficult for creditors of the policy owner to reach, because they would have to negotiate the laws of that jurisdiction to sue for recovery. 64 Some disadvantages of offshore PPLI include: Requirement of offshore purchase of PPLI. Rigid state insurance solicitation rules impact offshore PPLI in that policies may not be solicited or sold within the United States. To avoid state premium taxes, sanctions, fines, and penalties under state insurance regulations, 65 prospective policy purchasers must physically travel to the offshore location to purchase the policy or appoint a local agent in the offshore jurisdiction to purchase the offshore policy. 66 Foreign bank account and the new foreign account reporting legislation (Code 1471 to 1474, often referred to as FATCA). The regulations on foreign bank account reporting (FBAR), effective March 28, 2011, classify the cash value portion of a life insurance policy as a foreign account. 67 The regulations require any U.S. person to report a financial interest if he or she has one or more financial accounts located outside the United States when the aggregate value of the foreign accounts exceeds $10,000 at any time during the calendar year. 68 Additionally, FATCA requires disclosure on IRS Form 8938 of the ownership of cash value life insurance policies (in excess of certain cash value threshold amounts) issued by non-u.s. insurers. PPLI Planning and Estate Planning Life insurance planning dovetails with many estate planning concepts, such as using trusts, liquidity planning, gifting, and beneficiary designations, to avoid probate. Fundamental concepts of life insurance, including death benefit liquidity, tax-deferred accumulation, creditor protection of the cash value, gifting opportunities, and efficient wealth accumulation and wealth shifting through the use of PPLI, often comport with a client s estate planning goals. If the concepts of PPLI make sense for the client, the client s advisors would initiate the process of working with a suitable PPLI insurer, often by having the advisor solicit an illustration or ledger from a PPLI carrier. Medical and financial underwriting would occur, leading to the eventual purchase of a PPLI policy that complements the client s estate planning goals. In its most general terms, asset protection planning is the legitimate use of planning techniques and state and federal laws to protect assets from the reach of future unknown creditors. Life insurance generally, and PPLI specifically, offers numerous asset protection features, some of which are discussed below. Exemptions The state where the policy owner resides determines which exemption laws will apply. 69 Some offshore jurisdictions and more than half of the states exempt part or all of the cash value of a life insurance policy from the reach of creditors. 70 Some states also exempt the death benefit. States that provide unlimited exemptions to the cash value and death benefit include Arizona, Florida, Illinois, Kansas, Montana, Nevada, New Mexico, New York, Texas, and Wyoming. Many states also protect the death benefit payable to a trust. For example, Indiana, Maryland, Mississippi, New Jersey, New York, and Oklahoma have such statutes. 71 Colorado exempts up to $100,000 of the cash value and all of the death benefit, except where the death benefit is payable to the estate of the insured. 72 However, Colorado does not exempt contributions to the policy made within forty-eight months of attachment of a creditor s claim. 73 Ownership Structure There are several ways to protect assets through ownership structure. These are discussed below. The classic ILIT. An ILIT may own a PPLI policy and be designated as the policy s beneficiary, so that on the insured s death, policy proceeds will be paid to the trustee and distributed in accordance with the terms of the ILIT. Using an ILIT to own PPLI can offer significant asset protection and estate planning benefits, including those listed below. 1. An ILIT can avoid inclusion of the death benefit in the insured s gross estate through proper design that ensures the insured has no incidents of ownership Estate tax inclusion in the surviving spouse s estate can be avoided if the ILIT is to benefit the surviving spouse on the insured s death. This tax result is more favorable than if the surviving spouse were designated as the beneficiary of the policy and received the proceeds directly, because the proceeds remaining at the death of the surviving spouse would be included in his or her estate The PPLI policy and its cash value are not owned by the person seeking asset protection. Retitling of the asset out of the client s name into a trust is a hallmark of asset protection planning. 4. It is possible to take advantage of the gift tax annual exclusion amount via Crummey Power withdrawal provisions In 2012, it is possible to make tax-free gifts of up to $5,120,000 (or for a married couple, $10,240,000). 77 This taxfree gift provision currently is scheduled to expire on December 31, 2012, at which time the exemption will fall to $1 million, unless Congress takes further action The Colorado statute exempts [t]he proceeds of policies or certificates of life insurance paid upon the death of the insured The Colorado Lawyer July 2012 Vol. 41, No. 7 89

6 to a designated beneficiary, without limitation as to amount. 79 The Colorado exemption statute does not define a designated beneficiary, but the term would seem to include an ILIT. LLC as policy owner. Another technique is to establish an ILIT and a limited liability company (LLC), with the ILIT serving as a member of the LLC with other family members (for example, the insured s spouse) also being LLC members. The LLC then would purchase a PPLI policy. To avoid any estate tax inclusion, the insured should not be a member of the LLC. 80 The advantage of using an LLC and an ILIT is that the arrangement offers the flexibility to access the cash value and permits transfers of LLC interests rather than undivided interests in a policy to family members. It also allows for making gifts between family members of minority interests subject to lack of control and marketability discounts. This arrangement offers asset protection because of the limited liability nature of the LLC, and because the policy is not in the insured s name. For example, assume that the insured husband (H) creates an LLC whose members are his wife (W) and a newly created ILIT benefitting W and the children of H and W. The respective amounts of LLC interests owned by W and the ILIT would be determined based on the estate planning goals of H and W. H gifts sufficient funds to the LLC to enable the LLC to acquire a PPLI policy. Over time, W can transfer LLC interests to the ILIT, the value of which may be discounted using lack of control and marketability discounts. W can transfer her LLC membership interests by making annual gifts, which use up her annual exclusion, and/or she could use her unified credit. If W dies first, some or all of the appreciation in the cash value of the PPLI policy represented by the ILIT s LLC interests would pass to the children of H and W tax-free. In addition, W could receive tax-free distributions from the LLC rather than the ILIT from partial surrenders of the PPLI contract. Fraudulent Conveyance Issues There are strict prohibitions against using asset protection for fraudulent purposes. Most states, including Colorado, have adopted the Uniform Fraudulent Transfer Act (UFTA), under which a transfer is fraudulent as to present and future creditors if made with actual intent to hinder, delay, or defraud any creditor of the debtor, or if it would leave the debtor with unreasonably few assets to pay current and reasonably anticipated debts. 81 In the context of PPLI planning, the UFTA prohibits policy owners from making premium payments to defraud creditors. 82 Similarly, any interest or principal payments on policy loans cannot be made to hide assets from known or reasonably anticipated creditors. 83 Advisors working with clients in the initial planning stages must ensure that the client s purpose in establishing a PPLI is not to defraud creditors, and that the client will remain amply solvent after funding a PPLI policy. An Example of Custom-Designed PPLI H and W, a married couple, are both age 60 and in good health. They have three adult children and a $15 million estate consisting of: $8 million of investment portfolio assets producing primarily short-term gains and other ordinary income $2 million of pension assets $3 million of private equity assets consisting largely of illiquid business and partnership interests $2 million equity in their primary residence and second home. Their combined federal and state income tax rate is 40%. H and W have no debt. Their current employment earnings adequately sustain their lifestyle, and investment portfolio earnings generally accumulate, historically at approximately 8% per year. Their objective is to shift wealth to their children in the most taxefficient manner possible. The issue is whether the purchase of a $4 90 The Colorado Lawyer July 2012 Vol. 41, No. 7

7 million customized PPLI policy by H and W meet their goals of efficiently accumulating and shifting wealth to younger generations. The Numbers The numbers tell a story when compared with the alternative of simply doing nothing and paying income tax annually on investments. The numbers for the hypothetical situation described above are set forth in the accompanying chart. By purchasing a joint and survivor non-mec PPLI policy and using $4,000,000 of their 2012 gift tax unified credit, H and W will derive the following benefits from a PPLI policy: 1. Starting in year two, H and W s end-of-year cash value (net of all insurance expenses) will be greater than what would result from doing nothing and paying income tax annually. Based on life expectancies of approximately twenty-five years, such increased accumulation of assets inside PPLI resulted in accumulation of approximately $6 million more than if they had invested in a similar taxable portfolio outside a PPLI policy H and W will have tax-free lifetime access to the cash values in the form of partial withdrawals and tax-free loans. 3. H and W s children will receive a significant death benefit free of income taxation. 4. With proper planning as to gift tax issues and policy ownership, all growth of the cash value and the death benefit will be free of estate taxation on the deaths of H and W. 5. Unlike with many other estate planning techniques, such as grantor retained annuity trusts and qualified personal residence trusts, if H and W die prematurely, proper planning may keep all assets out of their respective estates. 6. H and W, through proper titling of the policy outside their own names and state exemptions, may enjoy a significant amount of asset protection of the cash values during their lifetimes. Through proper planning, they also may enjoy substantial lifetime access to the cash value. Conclusion A customized PPLI policy can legitimately allow investments to accumulate free of income taxes and to pass to beneficiaries free of income and estate taxes, while remaining beyond the reach of creditors and providing a significant death benefit to heirs. Given the potential benefits of customized PPLI, practitioners who advise high net-worth clients may wish to consider it as part of their overall estate planning, wealth accumulation, and asset protection strategy. Notes 1. Giordani and Jetel, Investing in Hedge Funds through Private Placement Life Insurance, 6 J. Investment Consulting 77 (Winter 2003/ 2004). 2. IRC 101 and See Budin, Life Insurance I, C (Tax Mgmt., Inc., 2006). 3. Lawson, An Introduction to PPLI, in The PPLI Solution, Delivering Wealth Accumulation, Tax Efficiency, and Asset Protection Through Private Placement Life Insurance (The PPLI Solution) 3-5 (Bloomberg Press, 2005). 4. The definition of life insurance is set forth in IRC A technical discussion of IRC 7702 is beyond the scope of this article. See Budin, supra note 2 at III, H (in-depth discussion of 7702). All life insurance policies also must comply with the diversification requirements of IRC 817(h). 5. Ratner, An Estate Planner s Guide to Insurance Products: An Objective Look at a Subjective Topic, ALI-ABA Estate Planning Course Materials J. 5, 19 (1999). Some insurers require a minimum premium commitment of $5 million. 6. To avoid registration of a private placement investment with the U.S. Securities and Exchange Commission (SEC), satisfaction of the accredited investor test is required under Regulation D of the Securities Act of 1933, as amended. 17 CFR (a). Satisfaction of the qualified investor test is required under the Investment Company Act of 1940, as amended. 15 USC 80a-2(a)(51)(A). See Ratner, supra note 5 at Ratner, supra note 5 at IRC 101(f). 9. IRC 7702A. See Cline, Dynasty Trusts V, E (Tax Mgmt., Inc., 2008). See also Riddle, Risk Management Redefining Safe Harbors, in The PPLI Solution, supra note 3 at Rev. Rul , CB 347; Rev. Rul , CB Id. 12. IRC IRC 2042(1) CFR (c)(2). See also Rev. Rul , CB IRC IRC Id. See also Browning, Tax-Free Life Insurance: An Untapped Investment for the Affluent, The New York Times F7 (Feb. 10, 2011). 18. This is referred to as the cash value corridor test, under which the death benefit is an adjusting multiple of the cash value. IRC 7702(d). Year Age Investment Investment PPLI PPLI Death End-of-Year Outside in PPLI Return Expenses Expenses Benefit Cash Value PPLI, if in Assumed as a % of a Taxable Cash Value Account 1 60 $1,000,000 $ 77,687 $ 32, % $14,251,358 $ 1,037,097 $ 1,048, $1,000,000 $ 160,346 $ 33, % $14,251,358 $ 2,150,538 $ 2,146, $1,000,000 $ 248,725 $ 45, % $14,251,358 $ 3,338,220 $ 3,297, $1,000,000 $ 343,076 $ 57, % $14,251,358 $ 4,606,778 $ 4,503, $ 0 $ 365,113 $ 50, % $14,251,358 $ 4,902,353 $ 4,719, $ 0 $ 502,764 $ 64, % $ 8,227,324 $ 6,759,648 $ 5,966, $ 0 $ 699,498 $ 83, % $10,563,831 $ 9,405,925 $ 7,542, $ 0 $ 973,926 $109, % $14,096,422 $13,095,507 $ 9,535, $ 0 $1,360,122 $141, % $17,958,401 $18,297,776 $12,054,427 The Colorado Lawyer July 2012 Vol. 41, No. 7 91

8 Under this test, a contract qualifies as life insurance if the death benefit at any time is greater than or equal to a fixed percentage of the cash value. This test ensures a relationship between the policy s cash value and death benefit. For example, at age 40, this percentage is 250; at age 65, it is 125%; at age 75, it is 105%; and at age 95 and older, it is 100%. 19. IRC 7702A sets forth the 7-pay test, under which the accumulated amount paid under the contract at anytime during the first seven years must not exceed the sum of the net level premiums that would have been paid on or before such time if the contract provided for paid-up future benefits after the payment of seven level annual premiums. IRC 7702A(b). See Budin, supra note 2 at H, 4 (in-depth discussion of IRC 7702A). 20. IRC 72(e). 21. IRC 72(v)(1). 22. See supra note Giordani and Jetel, supra note 1 at Riddle, Risk Management Redefining Safe Harbors, in The PPLI Solution, supra note 3 at Lee and Wilkey, Life Insurance A Practical Guide for Evaluating Policies IV, F, 4 (Tax Mgmt., Inc., 2010). 26. U.S. Securities and Exchange Commission, Variable Annuities: What You Should Know, available at nty.htm. 27. Bruno, Understanding and Comparing Costs, in The PPLI Solution, supra note 3 at , Fig Id. 29. Giordani, et al., Offshore Life Insurance Planning for U.S. Clients, 2000 A.B.A. Sec. Tax Rep. 2 at 4 (May 12, 2000). 30. Berlin, Policy Structure The Good, the Bad, the Ugly, in The PPLI Solution, supra note 3 at , Figs and Giordani, supra note 29 at Ratner, supra note 5 at Lee and Wilkey, supra note 25 at V, A, 3, a. 34. Ratner, supra note 5 at 20; Bruno, supra note 27 at Ratner, supra note 5 at Lee and Wilkey, supra note 25 at VI, B. 37. Surz, In Search of Skilled Investment Managers, in The PPLI Solution, supra note 3 at See Bermuda Segregated Account Act of 2000, as amended, available at The Companies Law of the Cayman Islands, as amended. 39. Lawson, supra note 3 at Tegeler, The Irrevocable Life Insurance Trust: Opportunities and Pitfalls, 1 J. Retirement Planning 35, (1998). 41. Id. at Slade, Personal Life Insurance Trusts, IV, C (Tax Mgmt., Inc., 2009). Proper drafting requires that the grantor not have any incidents of ownership in the policy. If the policy proceeds will be excluded from the grantor s estate, any amount the grantor contributes to the ILIT is a completed gift that may be subject to gift tax. IRC 2511; 26 CFR (h)(8). Additional planning may be required to minimize gift tax through proper use of the annual exclusion and unified credit. 43. IRC 2632; Tegeler, supra note 40 at 37, Berlin, supra note 30 at IRC 7702A(b). See also IRC 72(e). 46. Giordani, supra note 29 at Berlin, supra note 30 at Id. at 176, See IRC 817(h)(5) (authorizing use of independent investment advisors); Giordani and Jetel, supra note 1 at Rev. Rul , CB CFR (f)(2); Rev. Rul Rev. Rul , C.B Id.; Giordani and Jetel, supra note 1 at Lawson, supra note 3 at 4, Bruno, supra note 27 at 282; Giordani, supra note 29 at Williams, Jurisdiction Home or Away? in The PPLI Solution, supra note 3 at IRC 101 and 72(e). 58. IRC 2042 and Giordani, supra note 29 at Id. Offshore PPLI contracts are subject to the investor control rules and the diversification requirements of IRC 817(h). 61. King and McDowell, Trust Administration The Domestic Advantage, in The PPLI Solution, supra note 3 at 81, Fig Giordani, supra note 29 at 4. This can be avoided if the insurer has elected to be taxed as a domestic insurer under IRC 953(d). 63. Id. at 2, Id. at Id. at Giordani and Jetel, supra note 1 at CFR CFR (a), as limited to accounts of $10,000 or more by 31 CFR (c). 69. Rosen and Rothschild, Asset Protection Planning III, C, 5 (Tax Mgmt., Inc., 2002). See also In re Beckman, 50 F.Supp. 339 (N.D.Ala. 1943). 70. Williams, supra note 56 at 294. For example, the Bermuda Life Insurance Act of 1978, 26(1), provides an unlimited exemption to the insured of both cash value and death benefit. 71. Slade, supra note 42 at VIII, A. 72. CRS (1)(l). 73. Id. 74. IRC IRC See Crummey v. Comm r, 397 F.2d 82 (9th. Cir. 1968). 77. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No The Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No , CRS (1)(l)(B). 80. This would avoid creating an incident of ownership under IRC CRS CRS (1). 83. Id. 84. To save insurance costs especially in the later years, the death benefit was managed and reduced in approximately year eight, consistent with the IRC 7702 cash value corridor test. n 92 The Colorado Lawyer July 2012 Vol. 41, No. 7