EFTA01454212.pdf

FEATURE: STMENTS • Structuring Customized Account and inexpensive blocker of UBTI. The process of creating a new IDF with an investment A PPVA investment account eliminates UBTI manager and an investment mandate that a client finds by changing the character of the underlying IDF attractive has become dramatically less expensive. investment from UBTI to passive income. IRC Sec- As the time and cost to create a safe-harbor IDF has tion 72(u)(1) states that the income earned in an annuity declined, more and more top-tier investment manage- owned by a non-natural person won't be tax- deferred, ment firms have created. or are in the process of creat- but, instead, will be currently taxable as annuity income. ing. 1DFs to enable the most tax-inefficient segments of The PPVA investment account should enable tax- their investment portfolios (alternative asset class invest- exempt entities to invest without penalty in investments ments, such as hedge funds, high-yield bond funds, that would otherwise introduce UBTI. direct lending credit vehicles and high turnover port- The IRS has issued several favorable private letter folios) to be managed on a tax-deferred basis through a rulings to tax-exempt organizations. including endow- PPVA investment account ments and foundations, which have supported a PPVA investment account's ability to block UBTI.' Current UBTI blocker arrangements should be reviewed and compared to a PPVA investment account, particularly offshore arrangements that can be complex, expensive and potentially subject to greater scrutiny. How It Works IRC Section 72 states that a PPVA qualifies for tax treat- ment as an annuity ill In addition, many leading investment managers man- 1. It's administered by an insurance company and age more traditional multi-asset class portfolios in cus- allows for the systematic distribution of principal tomized IDFs. In many cases. a customized IDF can be over a period of payments' and created and attached to an insurance company segregat- ed asset account platform cost effectively with as little as 2. Its investment offerings arc structured as IDFs that S25 million. arc available only to qualified insurance companies.' There arc two basic rules that must be followed for an IDF to achieve deferral from current period taxation: PPVA investment account values arc treated as sepa- rate account assets and, therefore, aren't subject to the 1. Diversification. The IDF must be proper- claims of an insurance company's creditor. ly diversified. The diversification requirement is The reallocation of PPVA account assets from one defined in IRC Section 817(h) as: no more than IDF to another shouldn't be a taxable event, and the 55 percent of the IDF assets may be allocated to PPVA account can be transferred tax-free under IRC one underlying fund or security; no more than Section 1035 from one insurance company's administra- 70 percent of the IDF assets may be allocated to tion platform to anther's. Because there arc generally any two underlying funds or securities; no more no upfront fees relating to PPVA investment accounts, than 80 percent of the IDF assets may be allocated this transfer is a frictionless transaction. to any three underlying funds or securities; and Withdrawals from a PPVA account are taxed on a no more than 90 percent of the IDF assets may be last-in, first-out basis (with the taxable gain recognized allocated to any four underlying funds or securi- until all that remains is the cost basis), and there's a ties. A violation of the diversification requirement 10 percent excise tax on gains for withdrawals taken can result in the PPVA investment account being before the owner's age 59%.* subject to current period taxation on all embedded gains in the contract and cause the loss of tax deferral DECEMBER 2012 TRUSTS & ESTATES / wealthmanagennent.corn 25 CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 8(e) DB-SDNY-0112193 CONFIDENTIAL SDNY_GM_00258377 EFTA01454212