A few weeks ago I spent the day at an educational forum over barbecue, hosted by a national network of elite firms and financial professionals who serve high-income and business-owner clients. The topic on the table was complex private placement life insurance strategies — PPLI, for short — and why more of our mutual UHNW clients should be looking at it.
By the time the brisket was gone, I realized the more interesting conversation wasn’t really about PPLI at all. It was about the tool it’s quietly competing with: the swap power. So let’s talk about that.
This one’s for the business owners and investors I work with most — people who’ve built or sold a business, funded a trust years ago with appreciated stock or a piece of that business, and are now sitting on a lot more built-in gain than they expected. If that’s you, or it will be you soon, keep reading. The swap power still has its place in the toolkit. But it shouldn’t be the only tool you’re offered.
If you’ve built real wealth, you’ve met the “swap power”
If you’ve worked with an experiencedestate planning lawyer, you are probably familiar with the swap power — sometimes called a substitution power. It’s one of the most popular tools in the trust playbook for fixing an income tax problem that doesn’t show up until years after you’ve already signed the documents and forgotten the details. On paper, it’s elegant. In practice, once a family’s balance sheet gets large and complicated — which, if you’re reading this, yours probably is — it tends to get messy.
There’s another way to solve the same problem that sidesteps the mess entirely. It involves putting a specialized form of life insurance inside the trust instead of a traditional portfolio and hoping the swap power cooperates when you actually need it to. Let’s break down why.
The problem: old trusts, small basis, big gains
Say you funded an irrevocable trust years ago with stock, real estate, or a business interest, back when it wasn’t worth nearly what it is worth currently. Fast forward to today. For a lot of clients I work with, those investments have quietly grown into a meaningful chunk of the client’s net worth. But it also creates a tax problem.
When the trust eventually sells those investments — or your kids or grandkids do — the IRS taxes the gain: the difference between what the asset is worth now and what it was worth when it went into the trust. That original, low number is your “basis.” A low basis on a large position can mean a genuinely painful tax bill, the kind that shows up right around the same time as a very awkward family conversation.
The tax code does offer a fix. If an asset is included in someone’s estate at death, its basis “steps up” to fair market value on the date of death. All that built-in gain simply disappears for tax purposes. It’s a big deal, especially at the scale many of my clients’ portfolios have reached — which is exactly why estate planners like me spend so much energy trying to get appreciated assets back into someone’s taxable estate before they’re ever sold.
The go-to fix: the swap power
The most common tool for doing this with a traditional investment trust is the swap power. Here’s the idea: if the trust is structured as a “grantor trust,” you may have retained the right to swap assets with it. You hand the trust something of equal value — cash, other securities — and take the low-basis, appreciated asset out for yourself. Now you own it personally. If it’s still yours when you die, it gets a step-up in basis.
Sounds simple. Almost suspiciously simple. And it can work beautifully. But a trust built around a traditional portfolio and this strategy tends to run into real friction, and — this is the part that surprises people — the friction gets worse, not better, as the numbers get bigger.
Three problems that only get louder over time
Finding the right asset is harder than it sounds. You need to hand the trust something of exactly equal value, on demand, whenever the opportunity or the need shows up. Even with substantial personal wealth, you don’t always have a spare asset of matching value just sitting around, especially when much of your net worth is tied up in a business, real estate, or other holdings that don’t move quickly. Wealthy doesn’t always mean liquid, and I’ve had more than one client discover that the hard way, usually at the worst possible moment.
Timing is everything, and absolutely nobody controls it. For the swap to pay off, you need to still own the asset when you die. Nobody — not me, not your CPA, not your advisor with the very impressive spreadsheet — can predict that. Swap too early and you may give up growth or flexibility you didn’t need to give up. Wait too long, or get caught by surprise, and the plan never gets executed at all. Mortality is famously unwilling to work around estate planning deadlines.
Equal value doesn’t mean equal fit. You might find an asset worth exactly the same amount as what you’re swapping out, but that doesn’t mean it belongs in the trust for the long haul. It may behave differently than what the trust was built to hold, throw off income the trust doesn’t need, carry more risk than the family is comfortable with, or simply drift away from why the trust was created in the first place. A swap that balances on paper can still leave the trust holding something that doesn’t serve its actual goals — and that matters a great deal when a trust is meant to serve multiple generations, not just satisfy this quarter’s basis math.
In short: the swap power is a great idea that depends on a lot of moving parts lining up at once, using whatever asset happens to be available instead of what the mission actually calls for. Large, complex portfolios rarely cooperate that neatly. Neither, in my experience, do families.
A different approach: hold growth assets inside a PPLI policy
This is where PPLI comes in. Think of it as a customized life insurance policy built specifically for investors with significant wealth — not the kind of policy you buy off a shelf at your neighborhood agent’s office, and not typically practical below a certain level of investable assets. It’s built to hold sophisticated investments inside it, and it comes with two features that make the whole basis-step chase unnecessary.
First, the money grows without being taxed along the way. Inside a properly structured PPLI policy, investment growth isn’t taxed year to year the way it would be in a traditional brokerage account sitting inside the trust.
Second — and this is the real advantage — the death benefit comes out completely free of income tax. That’s not a step-up. That’s better. The tax code already excludes life insurance death benefits from income tax entirely. You never have to hunt for a matching asset to swap, time your death correctly (a strange sentence to type, but here we are), or end up with mismatched holdings that don’t fit the trust’s purpose. The tax problem simply never shows up, because the growth was never going to be taxed as a capital gain in the first place.
Just as important, the trust keeps holding what it was actually built to hold. No shuffling investments in and out to chase equal value. The investment strategy inside the policy can be built entirely around the family’s real, long-term goals — continued growth, multi-generational wealth transfer, funding future opportunities — instead of around whatever happens to be available to swap on a given Tuesday.
Worth saying clearly: this isn’t a free lunch
(Even that day over barbecue wasn’t free — someone had to expense it.)
PPLI isn’t for everyone, and it isn’t simple, even for families with substantial wealth. It works best for investors who can commit meaningful capital for the long haul. It comes with insurance costs and compliance rules, and it requires careful, ongoing structuring to keep its tax benefits intact. It is not a substitute for sitting down with your advisors and talking through your actual goals.
But if you’re a high-net-worth entrepreneur or investor whose trust holds a traditional investment portfolio, and the swap power is the only tool you’ve been shown for solving the basis problem, it’s worth asking a second question: could some of this be growing inside a PPLI policy instead — where the tax problem never shows up, and the trust never has to trade its long-term mission for a same-day equal-value swap?
Sometimes the best planning isn’t finding a clever way to fix a tax problem. It’s structuring things so the problem never exists in the first place.
Written by Frank L. Leffingwell
Partner in Charge, Austin