Private markets have gained significant traction among investors seeking attractive return potential with relatively low correlation to traditional public market assets. However, as with public investments, taxes can pose challenges, reducing the returns that fully reflect the economic success of the underlying investments. For taxable investors, asset location plays a critical role in optimizing returns. Specialized insurance products, such as Private Placement Life Insurance (PPLI) and Private Placement Variable Annuities (PPVA), can offer meaningful advantages for qualified investors, making them powerful tools in a tax-efficient investment strategy.

Private Placement Life Insurance: A Tax-Efficient Solution

PPLI is an advanced insurance product tailored to wealthy individuals seeking to combine the benefits of life insurance with access to private market investments. Unlike traditional life insurance policies, which primarily focus on providing a death benefit, PPLI policies enable policyholders to invest in a broad range of complex assets, including private equity, private credit, hedge funds and real estate.

The structure of PPLI is designed to maximize tax efficiency. The policyholder contributes premiums to the insurance policy, which are then allocated to Insurance Dedicated Funds (IDFs) or Separately Managed Accounts (SMAs). These investment vehicles are managed by professional investment managers to align with the policyholder’s objectives.

The PPLI structure typically provides the following advantages:

Tax-free growth. Investment returns, including dividends, interest and capital gains, grow on a tax-free basis. This means that policyholders do not incur taxes on the growth of the investments while the policy remains in force, providing the potential for enhanced capital compounding over time. PPLI is particularly advantageous for assets that would otherwise generate high levels of income taxable at ordinary income rates such as private credit or hedge funds because the tax-free structure shields their earnings from annual income taxes. Private equity, which typically benefits from capital gains rates, can also achieve more tax efficiency when held within a PPLI policy. The higher the returns of the underlying assets, the greater the compounding benefit.

Estate planning benefits. PPLI policies can be integrated into a broader estate plan. Upon the policyholder’s passing, the death benefit is paid out to beneficiaries on a tax-free basis. This feature not only preserves wealth, but can also provide liquidity to help indirectly offset estate taxes, ensuring a smooth transfer of assets to heirs.

Tax-free withdrawals. Policyholders can access tax-free liquidity up to certain levels by making withdrawals up to their cost basis and taking loans against the policy’s cash value, provided the policy remains in force. This flexibility enhances the utility of PPLI policies as part of a broader financial plan.

Investment flexibility. Policyholders can customize their investment strategies by selecting from a wide range of IDFs and SMAs, which include both traditional and alternative asset classes. This flexibility enables investors to align their portfolios with their long-term goals while accessing top-tier private markets managers and strategies, the number of which has grown over the past five years. This stands in contrast to the relatively limited investment options offered by traditional insurance products. In addition, assets within a PPLI account may be reallocated without triggering income tax liability.

Simplified tax reporting. Unlike many traditional private market investments, PPLI policies do not generate Schedule K-1s, which are commonly associated with partnerships and can complicate tax filings. By eliminating the need for K-1s, PPLI simplifies tax reporting for investors.

Over the long term, the returns generated within a PPLI policy should be expected to significantly outperform those of an identical portfolio in a taxable account, even after accounting for additional fees.

The following display illustrates the potential compounding benefit of a PPLI account purchased by a 50-year-old male with an initial $5 million value that grows at a 12% annualized rate of return. By year 10, the account value inside the policy would be $11.4 million (with a $15.3 million death benefit) compared to $7.4 million for a taxable account. By year 30, the account value inside the policy would be $99.4 million (with a $104.4 million death benefit) compared to $19.3 million for a taxable account.

Illustrative Example: Compounding Benefit of PPLI

Long-Term Growth of $5 million assuming 12% annualized rate of return

 

Source: Winged Keel Group. Net level annual rate of return of 12%. See the assumptions and disclosures at the end of this paper, which are an important part of this display.

Private Placement Variable Annuities: A Complementary Tax-Deferred Strategy

Similar to PPLI, PPVA offers a tax-advantaged structure for individuals and families. However, there are key differences in how these structures work and the benefits they provide.

A PPVA is an annuity contract where the investment component grows on a tax-deferred basis. Annuity holders allocate funds to the annuity, which are then invested in IDFs or SMAs. The growth of these investments is not subject to annual income taxes, providing a significant compounding advantage over time. Similar to PPLI, assets within a PPVA account may be reallocated without recognizing income tax. Unlike PPLI, PPVA does not include a death benefit, instead focusing primarily on the tax-efficient accumulation of wealth.

One of the distinguishing features of PPVA is the withdrawal structure: Distributions are taxed as ordinary income at the time of withdrawal, but the tax-deferred growth allows for potentially higher returns over the life of the annuity.¹ For philanthropically inclined investors, we believe PPVA is particularly compelling. Policyholders can designate a charitable organization as the beneficiary of the annuity, thereby eliminating taxation and helping to satisfy philanthropic objectives.

As shown below, a $500,000 investment in a PPVA that generates a 12% annual rate of return would grow to $1.3 million (after tax) by year 20 in a taxable account, $2.3 million in a PPVA account (after tax, upon surrender) and $4.4 million (tax-free) for a charitable recipient, with return benefits continuing to grow over time.

Illustrative Example: Compounding Benefit of PPVA for Individual or Charitable Beneficiary

Long-term growth of $500,000 Initial Investment, assuming 12% annualized rate of return ($mn)

 

Source: Winged Keel Group. Net level annual rate of return of 12%. See the assumptions and disclosures at the end of this paper, which are an important part of this display.

Considerations When Using PPLI or PPVA

While PPLI and PPVA may offer compelling benefits, they are not without complexities. Key considerations include:

Cost and complexity. These policies often involve higher fees, including mortality and expense charges, and require careful planning to ensure alignment with investor objectives.

Liquidity constraints. Private market assets are typically less liquid than public market securities, which may limit the investor’s ability to quickly access funds within a PPLI or PPVA policy.

Regulatory risk. Changes in tax laws or insurance regulations could affect the benefits and flexibility of these products.

Above all, the effectiveness of these policies depends on proper structuring and compliance with tax regulations. In our view, collaborating with experienced financial advisors, insurance brokers, tax professionals and legal experts is essential to ensure alignment with investor goals and legal requirements.

Making the Right Choice

PPLI and PPVA offer unique opportunities for individuals and families to access private markets in a tax-efficient manner. While PPLI is often better suited for those seeking a combination of estate planning and investment growth, PPVA can be ideal for investors focused on long-term tax deferral and philanthropic objectives. By leveraging the investment flexibility, tax advantages and structural benefits of these products, investors can align their portfolios with their broader financial goals.