New York, NY – Private credit has become increasingly popular among investors, with the market surging from $1 trillion in 2020 to $1.5 trillion at the beginning of 2024, based on data from alternative provider Preqin. Projections indicate that this figure will escalate to $2.6 trillion by 2029. Despite its growth, private credit investing comes with a significant drawback. Unlike long-term capital gains, returns from direct lending are taxed as ordinary income, subjecting investors to a top federal tax rate of 40.8%.
Tax considerations have led high-net-worth investors to seek alternative ways to invest in private credit. One method gaining traction is through insurance policies that allocate premiums to a diversified portfolio of funds. By utilizing insurance dedicated funds (IDFs), investors can potentially reduce their tax liability. These IDFs must adhere to IRS requirements by maintaining diversification, which could impact returns compared to selecting individual top-performing funds.
A cost-effective option for investing in IDFs is through private placement variable annuity (PPVA) contracts with insurance carriers. PPVAs can be suitable for clients with investible assets ranging from $5 million to $10 million. However, tax implications are only deferred until the policy owner withdraws or surrenders the contract, creating a future tax liability. Alternatively, private placement life insurance (PPLI) policies offer a more tax-efficient approach, as the death benefit paid to beneficiaries remains untaxed when structured correctly. Nonetheless, the upfront premium and rigorous underwriting of PPLI policies may deter some clients, despite the potential benefits for those with at least $10 million in investible assets.
To access unregistered financial products like PPLI and PPVAs, investors must meet specific criteria as accredited investors or qualified purchasers. Accredited investors need to earn a minimum annual income of $200,000 or possess a net worth exceeding $1 million, excluding a personal residence. Meanwhile, qualified purchasers must have investible assets of at least $5 million.
Despite recent scrutiny from Congress, the PPLI industry, described as a significant tax shelter exclusively used by wealthy individuals, continues to attract interest. Efforts to curb the tax advantages of PPLI have been proposed but face challenges in a Republican-controlled Congress. The ongoing demand for tax-efficient investment vehicles like private credit indicates a growing trend among family offices and ultra-high-net-worth clients seeking to optimize after-tax returns by exploring new avenues beyond traditional investment strategies.