High Net Worth (HNW) clients often approach private bankers for assistance in preserving their capital. A common strategy employed by private bankers involves the use of private placement life insurance. Private placement life insurance, otherwise known as insurance wrappers, allows investors to deposit bankable assets such as stocks and hedge funds into these financial instruments. By “wrapping” the assets with an insurance policy, insurance wrappers offer both asset protection and tax planning benefits. Since HNW clients are pegged to a higher tax bracket, this instrument has high appeal as it allows investors to pay less tax on investment income.
Structure of Insurance Wrappers
Insurance wrappers involve a life insurance policy that encloses the policy owner’s investment portfolio. The portfolio is owned and controlled by the insurer until it is time for the insurer to make payments. In exchange, the investor who purchases the insurance policy has to pay a premium, usually a percentage of the total investment portfolio. Under the ownership and control of the insurer, the investment portfolio accumulates income at favourable tax rates. When it is time for the insurer to make payments, the insured receives his investment portfolio, the accumulated income with an additional amount based on the premiums paid to the insurer. The policyholder will be able to make withdrawals before the death of the insured as long as the policy is classified as a non-modified endowment contract.
Tax Benefits of Insurance Wrappers
Insurance wrappers have several tax benefits
No Income Tax
The earnings on a policy’s cash value, which include interest, dividends and capital gains, are not taxable. However, the trade-off is that investors do not have control over the specific selection or retention of investments.
No Estate Tax with Planning
With proper estate planning, the policy may be structured in such a way that the death benefits are exempt from the taxable estate of the insured. This is subject to the executor being exempted from policy payments and the insured not retaining any form of control. Also, contributions made to the policy within three years of death are included in estate tax.
No Beneficiary Tax
Life insurance payments to beneficiaries upon death of the insured are excluded from the beneficiaries’ taxable income and capital gains tax.