And When I Die! – The Eternal Benefits of PPLI

grnowotnylaw
Sep 17
7 min read

Overview

When I review the Soundtrack of My Life, the common denominator in all of my musical interests is musical groups with horn sections. I started playing the trombone in the third grade. Unbeknown to me, the musical director for the Canal Zone Schools was a friend of my Mom and Dad and conspired with my parents to pick something that would discourage me from music lessons. I was too small to reach seventh position, but my parents underestimated my resilience. I participated in band and orchestra from that point through high school. In junior high school I also learned to pay the baritone horn and the tuba (a little).

Consequently, all of my music interests followed the great horn bands and any music featuring good horn sections – Blood, Sweat and Tears, Chicago, Earth Wind of Fire, Average White Band, and Tower of Power. I became a great jazz lover and also a huge fan of Afro-Cuban music aka Salsa. My belief is that any music genre can sound better with horn arrangements added to the music.

Take the folk music of Laura Nyro, a member of the Songwriter’s Hall of Fame. Her song And When I Die was first performed and recorded by Peter, Paul, and Mary. However, the best known version of the song was recorded by Blood, Sweat, and Tears where it hovered near the top of the charts in the U.S. and Canada. It proves my point, right!

This article introduces the concept of eliminating income and estate taxation on deferred income while providing multiple generations with tax-free income and accumulation using Private Placement Life Insurance (“PPLI”). Of course, the planning is maybe more than a little avant garde, but it works and can benefit many families. Keep reading!

The 600 Pound IRA

A Joint Committee of Taxation report in 2021 estimated based on 2019 numbers that there were at least 28,000 taxpayers with IRA assets in excess of $5 million. This number from an earlier report in 2014 reflected a three-fold increase in large IRA accounts from 2014. The same report also indicated at least 497 taxpayers with an average IRA balance of $150 million or more. Hence, the attack on “Stretch IRAs” and unlimited deferral was codified in the Secure Act of 2019 and the Secure Act of 2022. The planning reality is that most high net worth individuals have other assets and income to live on and would rather defer these assets as long as possible.

Attorney Contingency Fees – The Cousin on the 600 Pound IRA

In 2024, civil settlements in the United States reached the $40 billion mark for the third year in a row. In 2023, the market for personal injury lawyers and attorneys was valued at $57 billion. If the average contingency fee is thirty percent, personal injury attorneys made at least $17.1 billion. Morgan & Morgan, the largest personal injury law firm in the United States recovered $25 billion for its clients in 2024, while the firm made at least $7 billion. Cellino Law won $2 billion in settlements for clients in 2024. The National Practitioner Data Bank reported 10,217 medical malpractice payments in 2024, totaling $4.328 billion. Assuming a thirty percent contingency fee, attorneys made $1.3 billion.

I have frequently stated that trial attorneys have failed to take advantage of all of their available tax planning tools particularly, qualified settlement funds and offshore assignment companies. Furthermore, most of us “working stiffs” do not need ten lifetimes worth of deferred income. One or two lifetimes would be simply fine! For many attorneys this is, or easily could become, an attorney’s largest asset. The planning question is how to minimize the tax erosion brought on by income and estate taxation.

Taxation by Confiscation - The Murderous Combination of Federal Income and Estate Taxation

Federal tax law is very unkind to deferred compensation assets such as qualified retirement, IRA, and attorney deferral plans. The deferred income is subject to ordinary income taxation at the death of the taxpayer. The taxpayer is also subject to estate taxes if the gross estate exceeds the exemption amount for federal estate and death taxes. Lastly, the generation skipping transfer tax, when applicable, adds yet another layer of taxation.

Example 1

John Big Shot is a plaintiff’s attorney litigating medical malpractice and mass tort cases with his boutique litigation firm Big Shot Law in New York City. He has made better than a good living practicing law. His personal net worth is $40 million. He is divorced and has three children. He has previously deferred $10 million in settlements to an offshore assignment company. He does not expect to need the money. The cumulative tax impact at John’s death in 2025 is as follows:

Federal Estate Tax- $3,360,000
NY Death Tax- $1,600,00
GST Tax - $0
Federal and NY Income Tax- $3,320,000
Total Taxes - $8,280,000
Remaining Assets After Taxes - $1,720,000 or 17.2% of the Original Amount

The Testamentary Charitable Lead Annuity Trust (T-CLAT)

A Charitable Lead Trust is a charitable split-interest trust that can be created during life or at death, under a revocable trust or will. The lead income interest is paid to the charitable organization, and the remainder interest is transferred to a non-charitable beneficiary (e.g., the donor, the donor’s family). The income interest can be in the form of a “guaranteed annuity” interest (a charitable lead annuity trust (CLAT)), or it is a “unitrust interest” (a charitable lead unitrust (CLUT)).

For income tax purposes, CLTs can be drafted either as a grantor trust or as a non-grantor trust. If it is structured as a grantor trust, the donor receives an upfront charitable income tax deduction on formation of the trust and is then responsible for income taxes on future trust income.

A testamentary charitable lead trust (T-CLAT) is a trust created under a testamentary instrument, either a revocable or self-declaration trust, or under a will. The CLT pays an amount to qualified charities (either a private foundation or public charity) no less often than annually for a specific term (“the charitable lead interest”), after which the remaining assets generally pass to one or more noncharitable beneficiaries (usually family members) either outright or in further trust (“the family remainder interest”). If the CLT “qualifies” by meeting certain requirements under the Internal Revenue Code, the donor’s estate is entitled to an unlimited estate tax deduction for the value of the charitable lead interest.

The T-CLAT may be structured so that deferred income taxable at death receives an income tax deduction equal to the amount of the deferred income while removing the trust corpus from the grantor's estate, e.g., no taxation on the deferred income and no estate taxation on the deferred income.

PPLI for the Dead

Life Insurance and specifically PPLI can be an interesting investment solution for the T-CLAT following the taxpayer’s death. The planning question is how do you purchase life insurance for the life of the dead? You don’t! You purchase life insurance on the living. Nevertheless, PPLI can be an ideal investment for the T-CLAT and the taxpayer’s heirs following the death of the taxpayer. Consider group coverage issued with minimal medical underwriting with a group of friends, family, and/or former employees of your closely held company. PPLI is an institutionally priced, variable universal life insurance policy which offers customized investment options. Life insurers offer this specialty product in the domestic and offshore marketplace.

The T-CLAT may invest in an investment partnership that owns a PPLI policy that insures a group of lives that obviously does not include the taxpayer who died! The partnership is structured as a Freeze Partnership. The CLAT invests its corpus for a preferred interest which features a cumulative preferred investment return. The preferred membership interests represent ninety percent of the membership interests. The balance of the membership interests – ten percent – is owned by the Taxpayer’s Dynasty Trust. These interests are the common interests which are entitled to the excess investment return above the preferred return.

The sole investment of the Freeze Partnership is a PPLI policy insuring a group of multiple lives with guaranteed insurability. The policy is issued as a non-modified contract, so that loans and withdrawals from the PPLI Policy receive tax-free treatment. The Freeze Partnership investments accumulate on a tax-free basis, and the policy death benefits receive tax-free treatment.

The Freeze Partnership structure prevents current taxation to the T-CLAT. The Freeze Partnership structure provides the Dynasty Trust with the ability to receive tax-free income to the extent investment income exceeds the preferred return (say 3.5%). At the end of the T-CLAT term of years, the remaining T-CLAT assets revert to the Dynasty Trust.

The following example follows the facts in Example1.

Example 2

Attorney John Big Shot dies in 2025 with $10 million in a qualified settlement fund. John’s living trust has a T-CLAT. The trustee contributes $10 million of deferred income to the T-CLAT which provides for a 25 year term. The CLAT payments to John’s donor-advised fund over the 25 year term increases by 20 percent each year. The CLAT payment in Year 1 is $53,247. The final payment in Year 25 is $4,233,000. The charitable deduction is equal to $10 million. The estate also receives a full estate tax deduction for the contribution to the T-CLAT.

None of the CLAT investment income is taxable during the CLAT term of years since it invests all of its corpus into a PPLI policy owned by a Freeze Partnership. The Big Shot T-CLAT invests its $10 million corpus into a 90 percent preferred partnership interest (Class B) in a freeze investment partnership which provides for a three percent cumulative return. The Big Shot Dynasty Trust makes a $1 million investment for a 10 percent common membership interest (Class A) in the freeze investment partnership. The Class A member is entitled to all of the investment return in a year in excess of three percent.

The sole investment of the Freeze Partnership is a group PPLI contract with a customized investment fund. The policy is guaranteed issue, e.g., no medical underwriting. The policy that is issued is a Frozen Cash Value policy. The Manager of the Freeze Partnership may take loans and withdrawals to make distributions to the T-CLAT or Class A member, tax-free. The policy death benefits will receive tax-free treatment.

In Year 25, based on an investment return assumption, the reversionary interest to the Dynasty Trust is projected to be $29 million. The projected T-CLAT payments to the Donor Advised Fund are estimated to be $25 million. Due to the PPLI structure, the T-CLAT did not have any income taxes during the T-CLAT term.

Summary

The T-CLAT structure above provides an exciting planning alternative for taxpayers with large, qualified retirement plan, or IRA account balances at death. The same planning works very well for attorneys with large, deferred compensation arrangements. In some respects, it provides a better planning alternative to the Stretch IRA of recent glory. The planning eliminates both income and estate taxation at the taxpayer’s death while repositioning the T-CLAT assets for tax-free growth and distribution. The taxpayer does not have to wait for the T-CLAT term of years to end before they start enjoying tax-free benefits. Of course, this assumes reasonable investment performance. The planning in this article is outside of the box thinking, but provides an interesting approach to connecting the “dots” to minimize income and estate taxation.

By: Gerald R. Nowotny, Esq.