Blackstone's tax-free hedge fund pitch draws scrutiny

Senate Finance Committee Chair Ron Wyden is probing the use of private placement life insurance among wealthy Americans to avoid taxes, starting with a request for information from Blackstone Inc.’s Lombard International.

Private placement life insurance, or PPLI, is a decades-old strategy that has been gaining popularity among the super-wealthy as a way to protect their fortunes from income and estate taxes. A key perk is that the vehicles, which typically require a minimum investment of at least $2 million, can hold hedge funds and other financial products that would otherwise be taxed at the highest rates. 

“I am concerned that these insurance vehicles are being used without a genuine insurance purpose to invest in hedge funds and other investments while avoiding billions of dollars in federal taxes,” Wyden, an Oregon Democrat, wrote in an Aug. 15 letter to Stuart Parkinson, chief executive at Lombard, which had $67.4 billion of assets under administration as of the end of 2021.

Among the questions for Lombard, a wealth manager that New York-based Blackstone bought in 2014, include updates on its assets under administration in PPLI products, whether they’re marketed as a way to avoid taxes and whether Blackstone refers possible clients. Answers are due by Aug. 31.

A Wyden representative said the letter is just the start of the investigation and the probe will include looking at other firms.

After a little-noticed change in insurance law in 2020 made PPLI more lucrative, advisers have been pitching the strategy to wealthy Americans as a way to preserve their wealth for their heirs and dodge tax increases proposed by President Joe Biden and other Democrats. Firms have started competing to offer increasingly flexible PPLI options, with lower fees and a wider choice of investments, including hedge funds or credit products. 

While it’s not the simplest strategy — strict rules determine whether a policy qualifies as life insurance, which, in turn, gives the accounts their tax benefits — it can avoid federal and state levies that in some cases surpass 50%.

Internal Revenue Service rules also demand that policyholders relinquish day-to-day control of their PPLI’s decisions and that the portfolio must be diversified in certain ways. These complications are among the reasons why advisers have said wealthy Americans should devote at least $5 million to make the strategy worthwhile.

“By definition, these policies are only available to the wealthiest 1% of Americans and offer a myriad of tax advantages not available to most working Americans,” Wyden wrote.

The tax, climate and health bill approved by Congress this month doesn’t include Biden’s proposals to increase tax rates on wealthy individuals and their investment gains. However, the legislation — which Biden has said he will sign this week — does provide extra funding for the IRS to hire more auditors to scrutinize rich Americans’ tax avoidance strategies. 

[More: Advisers prepare clients for audits as stronger IRS enforcement looms]