| Overview
Over the course of the last eighteen years that I have been active in the recommendation of private placement life and annuity insurance solutions, I have had the opportunity to meet and solicit business with a number of private banks and specifically the private client groups within those banks in Switzerland and Singapore.
The U.S. Government announced on September 11, 2012 that it would pay UBS "Whistleblower" Brad Birkenfeld $104 million. Unfortunately, Mr. Birkenfeld will have to wait a few months until he gets released from house arrest in order to enjoy his $104 million for his role in disclosing to the U.S. Government the name of 5, 000 accounts held by Americans within the private client group of UBS.
The story of UBS goes something like this. Brad Birkenfeld was a fifteen year veteran of UBS. Over the course of his career, he helped over 5,000 wealthy American taxpayers hide over $20 billion in Swiss bank accounts. After "blowing the whistle" on UBS, he ended up getting convicted himself for not being forthcoming enough initially. He apparently pleaded to a lesser charge in exchange for his cooperation.
If Private Banks had listened to tax compliant and transparent structuring their story would not have ended up this way.
A number of legitimate planning techniques with lots of statutory authority in the Internal Revenue Code exist that would have provided the benefits desired without the use of the illegal strategy of hiding the money under a "rock" and hoping that nobody finds out.
Legitimate techniques exist in U.S. Statutory Life Insurance, Annuity and Regulated, Registered and Recognized Retirement Plans:
B. Life Insurance and Annuity Background
Private placement life and annuity contracts are institutionally priced products designed for the same type of clients that private banks, brokerages,trading platforms, investment banks and asset managers desire.
These products allow for investment customization that would allow the UBS's of the world to provide a complete platform of customized investment options for private bank clients on a tax-advantaged basis.
The investment menu could have complete open architecture to include bank-managed funds and discretionary accounts as well funds managed by third party managers approved by the bank.
The tax treatment of life insurance and annuities are bullet-proof from a statutory point of view. The tax law definition of life insurance is defined in IRC Sec 7702. The tax law definition of an annuity is defined in IRC Sec 72. Life insurance policy loans and withdrawals are also covered in IRC Sec 72. The tax law requirements for variable insurance requirements are defined in IRC Sec 817 and Treasury Regulations.
The tax treatment of a life insurance death benefit is covered in IRC Sec 101. The estate tax treatment of the death benefit is
covered in IRC Sec 2042.
The tax treatment of insurance companies is covered in Sub-chapter L of the Internal Revenue Code (IRC Sec 801-IRC Sec 818). Each state or offshore jurisdiction has a statute dealing with the treatment and legal requirements of insurance company separate accounts.
Private placement life insurance policies enjoy significant tax-advantages. The investment income within the policy is tax-free. The policyholder also has the ability to access the policy cash value during lifetime on a tax-free basis though low cost policy loans (0-50 basis points per year).
Life insurance also allows the policyholder to recover his basis in the contract first on a tax-free basis as well.
The death benefit of a life insurance contract is income tax-free. The policy's ownership can also be arranged so that the policy proceeds avoid estate taxation for multiple generations.
In other words, IRS rules allow a policyholder to enjoy the tax-free build up of investment income within the contract; enjoy tax-free income during lifetime; and at death enjoy income and estate-free tax treatment of those investment gains.
Isn't that what UBS and its clients were trying to accomplish?
What other investment vehicle offers similar tax benefits on a statutory basis?
Private placement variable annuities (PPVA) contracts also provide significant tax advantages albeit but not like PPLI. The investment income within the policy enjoys tax deferral. In the event deferred income is converted into a stream of payments (annuitization), part of each payment is treated as a tax-free return of capital and part of each payment is treated as income taxed at ordinary rates.
At death, deferred income can be continued to enjoy further deferral for at least another five years, or paid out over the lifetime of a beneficiary extending the deferred benefits.
C. Private Banks and Private Placement insurance Products
Over the course of the last eighteen years I called on private banks in both Switzerland and Singapore. However, the level of business never approached any meaningful amount for a few important reasons:
(1) Product Complexity and Sophistication
Most banks previously had no experience selling insurance products; however since the repeal of Glass-Steagal, banks have been the largest seller of annuities by large margin. Investment brokerage firms would probably be a close second particularly in the area variable annuities.
On the life insurance front, banks have been less successful in selling life insurance products. In my view it does take more sales ability to sell life insurance and the estate planning considerations for wealthy clients can be complex.
Nevertheless, this should not have been difficult for private banks with trust companies.
In the final analysis, private banks and investment brokerage firms sell complex investment product and strategies that are more far-flung in my opinion than life insurance and annuities.
(2) Bureaucracy
A number of life insurers got tangled up in long reviews with compliance departments while at the same time, other departments within the banks were involved in "crimes and misdemeanors" that resulted in far greater negative publicity than the sale of life insurance and annuities. I suppose in their case profits "trump" compliance.
(3) Marketing and Distribution
Most private placement life insurers do not have marketing resources internally. High end life insurance salesmen have avoided selling private placement insurance products not because of the absence of competitiveness but because of the absence of high commissions.
Private placement insurance contracts compensate the distributor in a manner similar to investment products with asset-based compensation.
(4) Professional Arrogance
Another reason is professional arrogance. Traditional banks and investment firms quite frankly look down their nose at life insurance companies and agents. To put it another way, it was beneath the banks to sell life insurance products.
(5) No Enforcement: There WAS no Foreign Account Tax Compliance Act (FATCA) and Passive Foreign Investment Company (PFIC)
reporting was ignored.
The Foreign Life Insurance Industry has more investment options. The offshore private placement industry has more asset protection options as it permits assets-in-kind contributions and bankable asset contributions.
Generally, "offshore" jurisdictions also have wider and deeper investment choice and flexibility along with stronger asset protection benefits.
Many foreign insurance carriers are fully compliant with U.S. law. These carriers have made an election under IRC Sec 953(d) to be treated as U.S. taxpayers and are subject to review by the IRS. Nobody is hiding! FATCA does not serve as a deterrent to considering offshore options because it has defined the rules of engagement and enforcement.
Summary and Recommended Solution
In addition to the above benefits described there is also the purpose for U.S. Connected Persons to prevent their Foreign Bank or Investment Account from shutting them out. Legally eliminating some or all U.S. reporting obligations keeps the Foreign Financial account doors open to U.S. and U.S. connected persons.
Potentially FATCA, PFIC, FBAR and IRS Form 8938 Foreign Asset Reporting becomes irrelevant and our clients are able to open a Foreign Investment Account without U.S. Person restrictions.
For Example:
If you have gotten kicked out of your foreign mutual fund, bank or trading account (or about to be!), the recommendation below is for you and, The walls are closing in on Americans quickly. If your foreign bank hasn't already closed your account, don't hold your breath because it is probably coming quickly.
A large number of excellent articles have covered the implementation of FATCA and reporting obligations of FBAR, PFIC and IRS Form 8938.
FATCA basically requires foreign financial institutions to report their American citizen account holders to the Feds beginning in 2014 or face the consequences of a 30 percent withholding tax on the financial institution's U.S.-sourced income. Foreign Financial Institutions releasing funds to the USA must also withhold 30 percent.
PFIC has always been a problem when holding a foreign account and FBAR and Form 8938 non-compliance carries penalties that will keep U.S. Persons up for more than a few nights and erase years of savings and investment. Lie about the existence of a foreign account on Schedule B of Form 1040 and your client may have committed tax fraud.
We have identified a strategy to achieve tax-advantaged wealth accumulation while legally eliminating the U.S. reporting obligations mentioned previously. Eliminating reporting requirement leaves the door open for U.S. Persons to establish a foreign account. The Regulations are very clear that Private placement insurance contracts in U.S. Commonwealths are not subject to these reporting requirements:
Private Placement Insurance Products
Foreign Private placement insurance contracts are institutionally priced; customized variable universal life insurance and private placement variable deferred annuity contracts. At least one private placement life insurer has a private placement variable immediate annuity contract. ($ 5,000.00 per month per $1 million and increases if performance is more than 3.5% annual) These products are limited to accredited investors or qualified purchasers as defined under federal securities law. Basically, these are insurance contracts with super-charged investment flexibility; which includes foreign real estate.
These policies offer customized investment options for policyholders. The policies must be compliant under U.S. tax law for American citizens and resident aliens. Tax Requirements for U.S. Insurance Contracts Variable annuity contracts have a specific definition within the Internal Revenue Code, IRC Sec 72. Additionally, variable annuities also must also comply with the rules for variable insurance products found in IRC Sec 817(h) and Treasury Regulation 1.817-5.
Variable universal life insurance contracts must comply with the tax law definition of life insurance found in IRC Sec 7702 as well as the diversification requirements in IRC Sec 817(h) and Treasury Regulation 1.817-5.
As previously discussed both products are tax-advantaged. Variable annuities provide for tax-deferral on investment income. Depending upon whether the account value is annuitized, i.e. converted to a monthly payment for a term of years of lifetime income, a portion of each payment (exclusion ratio) is tax-free. Income that is not annuitized is normally fully taxable when distributed.
Life insurance receives very favorable tax-treatment. The investment income within the policy is not subject to current taxation. The policy is able to access the investment gains within the policy on a tax-free basis through partial surrenders of the cash value and very low cost policy loans. Ultimately, the death benefit will be income tax-free and possibly estate tax-free.
For the American taxpayer overseas, the majority of U.S. tax treaties have annuity provisions provide for no tax on annuity income in the Host Country and only in the Home Country when a distribution is taken. (Growth within an Annuity is Tax Deferred in Germany) One subtle difference between domestic and offshore policies is the ability to make premium payments in kind or non-cash. The assignment or transfer of an appreciated investment portfolio is treated as a sale or exchange for tax purposes and triggers a taxable gain (or loss).
FBAR, Form 8938 and Offshore Life insurance
The regulations for FBAR and Form 8938 treat an offshore life insurance policy as a foreign account for reporting purposes. Therefore, a transfer to an offshore life insurer in Bermuda or Cayman Islands does not fix the taxpayer's reporting obligation, i.e. TDF 90-22.1 and Form 8938. These rules apply to American policyholders regardless of whether or not the offshore life insurer makes an election under IRC Sec 953(d) to be treated as a U.S. taxpayer. The regulations are very clear that accounts in certain U.S. commonwealths such as Puerto Rico, Guam, American Samoa, U.S. Virgin Islands and the North Marianna Islands are not subject to these reporting requirements.
Isla Del Encanto - Boricua Life
The commonwealth of Puerto Rico (PR) has its own tax code. Largely, the tax code in PR follows the Internal Revenue Code almost verbatim. The Commonwealth Government has always been very clever and had great foresight in stimulating the local economy by offering strong tax incentives for corporations operating in Puerto Rico.
In the last year or so, Puerto Rico has updated its insurance legislation to encourage the formation of insurance companies operating internationally in Puerto Rico. In effect, Puerto Rico has become on "onshore -offshore" jurisdiction for insurance. Puerto Rico also has strong separate account legislation which segregates the assets in a variable life insurance or annuity contract from the claims of the insurer's creditors.
Several life insurers issue private placement U.S. tax compliant life insurance and annuity contracts. These companies absorb very little risk. Virtually all of the mortality risk is shifted to investment grade reinsurers. Additionally, the separate account or investment assets of the policy are custodied with large independent financial institutions.
It may be possible to retain the client's current foreign financial institution as the custodian for the policy separate account. The foreign financial institution may take exception to this treatment if the account has any U.S.-source income.
Additionally, the foreign financial institution may require the applicant to be a 3rd Party Administrator/ Trustee which we have already organized for our clients.
From a "going concern" point of view, the PR life insurers are established as operating companies meaning they have reached a threshold level of business to remain in business. As a result, it does not really matter that the company does not have the same financial ratings as Northwestern Mutual or MassMutual. Policies issued to an American citizen or resident alien are not subject to reporting obligations of FBAR. PFIC and Form 8938.
Summary
The implementation of FATCA, the expansion for tax information exchange treaties and reporting obligations under FBAR and Form 8938, suggest that the tax holiday is over for Americans. If you have just gotten kicked out of your foreign mutual fund, bank or trading platform (or about to be!), the recommendation outlined above might be an interesting solution for you.
The ability to transfer your cash, assets and investment portfolio into a structure that is compliant for U.S. tax and simplified tax reporting purposes while achieving tax-advantaged accumulation is a powerful solution to the problem.
TAKE ACTION! U.S. Persons who are ready to set-up an IRA LLC contact us today for a free no-obligation consultation.
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