Miriam Gottfried (WSJ): ‘A Roth IRA on Steroids’: Wealthy Americans Find Another Tax-Free Way to Invest
Enter private-placement life insurance, a customizable insurance contract that allows unlimited investments to grow tax-free.
“It is a Roth IRA on steroids for people who can afford it and want to leave it to their heirs,” said Jim White, founder of Great Oak Wealth Management.
The policies have surged in popularity among wealthy individuals, who use them to invest in alternative assets such as hedge funds, private credit and private real estate. Such investments can come with higher returns—and hefty annual tax bills.
But there is a major catch. To comply with Internal Revenue Service rules, the investor must give up control of the assets within the policy. That means putting the money in a specialized private investment vehicle known as an insurance-dedicated fund or a separately managed account whose investments are sourced and overseen solely by their adviser.
Created in the early 1990s, private-placement life insurance takes advantage of tax-code provisions intended to encourage people to provide for their dependents using life insurance. The policies began gaining traction a little over a decade ago when wealth advisers realized they could manage—and charge fees on—the assets, which are essentially locked up for years.
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The executive’s investments could one day be worth hundreds of millions of dollars, and he won’t have paid a dime in ordinary-income or capital-gains taxes on their growth. He can take withdrawals or loans against the policy’s cash value but generally doesn’t expect to tap the proceeds. When he dies those will go to beneficiaries income-tax-free in the form of a death benefit.
His policy is inside an irrevocable trust set up for his children—a structure often recommended by advisers—meaning it also wouldn’t be subject to estate taxes.
“It’s a way to create a tax-efficient wrapper around tax-inefficient investments,” said Callahan, who heads up BFA’s family wealth planning.
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Some in Congress would like to see private-placement life insurance lose its tax-free status. Sen. Ron Wyden (D., Ore.) in April introduced legislation that would separate it from traditional life insurance, making its earnings and losses taxable to the policyholder as they are earned each year.
“We cannot have a bunch of ultrarich tax dodgers abusing its special tax treatment to set up tax-free hedge funds and shelter mountains of cash,” Wyden said in a press release announcing the legislation.
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