In most instances, the needs of the ultra high net worth client simply cannot be met through the use of the traditional retirement planning vehicles and strategies that are useful to even the moderately wealthy client. The traditional tax-preferred planning vehicles can create undesirable limits for these ultra wealthy clients, who have more cash to spare and require high performing investment vehicles. Private placement variable annuity (PPVA) investments are fast becoming the luxury vehicles of the future and — for the truly wealthy client — PPVA investments can provide a combination of tax benefits and investment control that drive tax and retirement income planning to the next level.
What is a private placement variable annuity investment?
A PPVA investment is an annuity that is available only to high net worth clients who qualify as accredited investors (and, practically, qualified purchasers), meaning that they meet certain requirements as to net worth and investment sophistication. It is an annuity in that it is treated as such for tax purposes, but the similarities to the traditional retail annuities that most clients associate with the term ends there. PPVA investments do not offer the types of income guarantee riders and protection against market risks that today’s retail annuities typically make available.
Instead, the draw of the PPVA investment is the investment flexibility and tax-deferred growth that these types of accounts offer. The client has the freedom to make additional deposits to the annuity and change investment allocations based on a number of investment options. Typically, these annuities will give clients a choice of investments that includes nontraditional investment options, such as hedge fund and private equity investments that have the potential to generate substantial returns.
Taxes on the account growth are deferred until the client begins taking annuity payouts (a 10 percent penalty charge applies if distributions begin before the client reaches age 59½). In order to qualify for this favorable tax treatment, the PPVA investment must offer only investment options that are available solely to qualified insurance companies.
Further, the underlying asset allocations must meet certain investment diversification requirements — for example, no more than 55 percent of the client’s assets may be allocated to any single investment and no more than 70 percent may be allocated to any two investments. The client has control over investment allocations but cannot have control over the investment choices that are offered within the PPVA investment — an independent investment manager must have discretion to choose the investments that will be made available to the client.
Unconventional planning opportunities for the ultra wealthy
Though most high net worth clients will be taxed at the highest federal tax rates even in retirement, the tax benefits of a PPVA investment can be substantial. Many of these clients are interested in allocating at least a portion of their wealth to nontraditional investments with high growth opportunities, such as hedge funds, that are often taxed at the highest possible tax rates (for example, short-term capital gain rates as opposed to the lower long-term rates). The PPVA investment can allow the client to defer this taxation, thus potentially increasing the value of the account that is left to grow over time.
Further, for clients who intend to retire in states with lower (or even zero percent) income tax rates, a PPVA investment can allow them to defer taxation of the account’s growth — which can be substantial — until a time when they are subject to lower state and local income tax rates.
Importantly, the beneficiary designation of the PPVA investment is revocable throughout the client’s life. This gives a client who desires to make substantial charitable gifts the flexibility to name a charity as the PPVA investment beneficiary — thereby potentially eliminating all taxes on the account growth — but retain control over the assets during his lifetime.
This strategy is attractive primarily because of the revocable nature of the designation. In many cases, in order to maximize the tax benefits of a charitable gift during the client’s life, the structure of the gift must be irrevocable. With a PPVA investment, the client is able to access the funds should his needs change throughout life.
