Frequently Asked Questions
A. A life insurance policy is a product you buy from a life insurance company through one of its licensed insurance agents or brokers. The content of the policy is determined by the life insurance company and generally is the same content for all policyholders.
A custom designed life insurance contract is something you enter into with the insurance company that does not sell life insurance policies. The content of the contract is determined based on the uniques needs of each client.
This answer may be a surprise to many since so many “experts” promote life insurance in such a manner. One “expert” goes so far as saying “the core motivation for acquiring PPLI is to establish a tax-free investment environment”. While life insurance can and should provide many benefits, to think of it only in terms of avoiding income tax is potentially an excellent way to get your client into trouble. It is clear Congress made certain provisions to help ensure the primary motivation in entering into a variable contract is the traditional economic protections provided by life insurance. Below is the applicable portion of the Senate Committee Report (emphasis added)
From the Committee Reports on P.L. 98-369 (Deficit Reduction Act of 1984)
The bill adopts a provision that grants the Secretary of the Treasury regulatory authority to prescribe diversification standards for investments of segregated asset accounts underlying variable contracts. The diversification requirement is provided in order to discourage the use of tax-preferred variable annuities and variable life insurance primarily as investment vehicles. The committee believes that, by limiting a customer's ability to select specific investments underlying a variable Contract, the bill will help ensure that a customer's primary motivation in purchasing the contract is more likely to be the traditional economic protections provided by annuities and life insurance.
A. The answer to this question depends on if you are looking for an off the rack life insurance policy or a true customized solution to your long term estate and financial planning.
A life insurance company that provides a pre-written tax opinion as way to attract business is most likely in the business of selling pre-written PPLI and PPVUL life insurance policies and promoting PPLI/PPVUL primarily as a way to avoid income tax. A true custom contract solution means your life insurance contract drafting starts only after your advisors work out the details of your overall plan. Since each custom contract of life insurance is specifically designed to meet the unique needs and situation of each client the off the rack approach cannot work.
Each high net worth client has a specific and unique set of long term estate and financial planning issues that only a custom drafted contract solution can solve. PPLI and PPVUL are generally life insurance policies that are marketed and sold as ways to avoid income tax on investments as opposed to a custom contract that is settled as a long term (lifetime) estate and financial planning solution.
There are some key items that make a long term custom contract solution work. One is keeping costs down. The other is the efficient investment of the reserve that supports the life insurance policy. The reserve (marketed as cash value) is not subject to tax, but only because it is understood that if the yield was reduced by tax it would be impossible for the insurance company to properly reserve for the eventual claim. The other is the use of a custom contract of life insurance, not as a tax shelter, but rather to provide the traditional economic protections life insurance was intended to provide.
A. An independent investment manager.
There should be no hidden arrangement with the life insurance company when it comes to the investment of the reserve. Investments should be made based on what is good for the custom life insurance contract and not what is good for the insurance company. The entire upside to the investment of the reserve should inure to the benefit of the contract owner and his/her beneficiaries. As long as the tax rules are respected the investment manager can be someone the client knows and trusts.
Internal Revenue Code (“Code”) Section 817(h)(5) specifically states that “independent investment managers are permitted.”
A. It is assumed life insurance must be sold a regulated and pre-written policy of insurance. This is most likely because we all grew up with this understanding. But it is simply not true.
The Code never uses the term policy. Rather life insurance is referred strictly as a contract in the Code. As long as the life insurance contract is tax compliant and is a contract of insurance (provides for risk shift and risk distribution) then there is no barrier to custom drafting a life contract insurance solution. See, especially, Code sections 817 Treatment of Variable Contracts and 7702 Life Insurance Contract Defined.
A. The term Variable Contract can mean two entirely different things.
In the U.S. a “variable” life insurance policy is a marketing term and is used to describe cash value life insurance policies where the owner can chose how the cash value is invested from a set list of investment funds selected by the insurance company.
In the custom contract situation a “variable” contract of life insurance is a tax reference only. Under the Code a variable contract is a special contract of life insurance where the insurance company intentionally segregates the custom contract premium into its own segregated account that is protected from creditor claims. The investment of the premium is the reserve for the custom life insurance contract. The reserve set aside in the segregated account can only be used by the insurance company for the specific custom contract of life insurance it was set up for. The reserve is invested by the independent investment manager.
A. As with most long term estate and financial plans there is a death and a lifetime component.
A custom drafted solution not only solves the specific issues of each client, but it is far less expensive to design, implement and administer such a solution. Given that the overall costs, especially the long term costs, are much less, the long term death benefit as well as the lifetime safety net features that are part of the traditional economic protections of life insurance will also be greater.
A. Here is a partial list:
· Can be designed to better coordinate with other long term estate and financial planning techniques
· Helps assure delivery of maximum death benefit when it is needed the most
· Provides a financial safety net during life if there is a need for the same
· Can be multi jurisdictional compliant
· Drafted to client specifications
· Independently managed reserve
· Creditor protected
· Shifts wealth income and estate tax free
· Simple and far less administration issues than complicated estate planning techniques
A. Three of the biggest problems with complex estate tax planning techniques are (1) complex, ongoing and often times expensive administration issues; (2) once started very difficult to stop without significant cost and perhaps economic loss; and (3) the success of estate tax savings comes at the cost of the eventual income or capital gains tax that will be imposed on the shifted wealth.
A custom contract of life insurance should be a profit as opposed to cost proposition. Ongoing administration is not complex or expensive. Reduction or elimination of future estate tax would simply mean more money eventually going to the family with the custom contract automatically adapting to the changes to provide new benefits to the family. The custom contract of life insurance also means all shifted wealth will be delivered estate and income tax free.
A. You should expect complete transparency and that the certain costs can be negotiated as part of the custom contract process.
From the perspective of the life insurance company there are really only three costs: (1) the set up costs; (2) the annual administration costs; and (3) the cost of insurance. Each of these costs can and should be set forth in a manner that is transparent, understandable and guaranteed. You should also know if the cost of insurance charge is marked up to provide profit/revenue to the life insurance company. CastleRE does not mark up the cost of insurance component. CastleRE negotiates its annual fee and once settled is guaranteed and becomes part of the final custom contract of insurance. In most situations the insurance company charges, including the cost of insurance, should average 100 basis points or less annually over the life of the insurance contract.
A. The primary reason to go offshore has nothing to do with tax rather it is because the regulatory environment of the right jurisdiction will allow for each life insurance contract to be custom drafted so that it can solve the unique issues of each client.
In the U.S. life insurance is regulated at the state level. Regulation requires consistency in the policy form used by domestic life insurance companies. This means boilerplate. A boilerplate policy form cannot be tailored to meet the unique needs of each high net worth client.
CastleRE is a 953(d) elected life insurance company. This means CastleRE has chosen to be taxed as a U.S. life insurance company. This not only saves imposition of federal excise tax, but there is a state premium tax that may also be avoided.
A. There is no such thing as a DAC tax.
Many life insurance companies charge an upfront cost labeled by the insurance companies as a “DAC tax”. This is true of both domestic and many life insurance companies located outside the U.S. The reality is there is no such thing as a “DAC” tax. CastleRE imposes no such charge.
The client deserves to know and understand what the costs are, including any mark ups or other payments to the insurance company such as splitting of investment fees and charges. CastleRE does not mark up any costs; takes no share of any investment fees or charges; and openly negotiates its administration and profit charge. All costs and charges are guaranteed as part of the final custom contract of life insurance.
The content, ideas, phrases, and expressions “Advised Life”, “custom contract life insurance”, “New Standard”, no matter what form they are in or font used are the exclusive property of Castle Re Insurance Company, Ltd and the author. No part of this Q&A may be reproduced in whole or in part without the expressed written consent of Castle Re Insurance Company, Ltd. All parties must consult with their own tax and legal advisors with respect to all tax and legal matters. This Q&A is not intended nor can it be relied upon by any party as tax or legal advce.