Bridging the Liquidity Gap: Life Insurance in PE/VC Estate Planning

By Erik Berge | Senior Wealth Strategist, Citizens Private Wealth

Planning for estate and liquidity challenges in drawdown funds

Carried interest, general partner stakes and private shares may represent meaningful value to the private equity (PE) or venture capital (VC) investor, but these holdings don't always convert cleanly or quickly into cash. If death or disability strikes during the life of a fund, heirs may face significant financial uncertainty with inaccessible assets and years of potential delay before any meaningful monetization.

While the main purpose of obtaining life insurance is the need for a death benefit, life insurance, if properly structured and thoughtfully integrated, can provide a critical financial bridge for smoothing liquidity gaps, covering tax obligations and helping families maintain stability while a fund's longer-term value plays out.

Integrating life insurance into a comprehensive estate and financial plan

Life insurance is often viewed narrowly as a standalone tool for replacing income or covering estate taxes. And it can work well to serve this purpose. However, decisions about the type of policies, timelines and coverages are most effective when life insurance is not viewed in isolation, but as a key component of a broader estate and financial planning strategy.

For professionals in the PE/VC space, life insurance can help create a more cohesive and resilient plan when aligned with fund timelines, tax strategies and long-term wealth transfer goals.

This alignment is especially important given the illiquid and long-dated nature of many fund interests. For instance, a policy held in trust can provide liquidity to cover estate taxes without forcing a sale. It can also ensure that capital calls are met even if a partner becomes incapacitated or passes away mid-fund.

It can be tempting to delay life insurance conversations, but getting started early offers the greatest flexibility in policy design and cost, ensuring that coverage is in place before health or age become limiting factors. This early planning becomes even more critical when navigating the unique complexities of private equity and venture capital, where long fund lifecycles, illiquid interests and partnership dynamics demand tailored insurance strategies.

Because of this complexity, insurance decisions should be made in coordination with estate counsel and financial advisors who understand the nuances of PE and VC fund interest and the context for how they fit broadly with the investor’s total balance sheet.

Planning for premature death or disability during the fund lifecycle

PE/VC professionals often operate within structures that are not easily unwound. If a partner becomes disabled or passes away during a fund's lifecycle, the resulting disruption can create significant financial and operational challenges, both for the firm and the family. Without proactive planning, estates may face liquidity shortfalls, unresolved capital commitments and delays in asset transfers.

Planning needs often overlap, but the specifics may differ between general and limited partners:

General partners (GPs):

While many GP agreements address death or incapacity, gaps can still exist. It’s essential to understand how a GP's carried interest, both vested and unvested, would be treated in these scenarios. Key considerations include:

• Buy-sell provisions: Without them, surviving partners and heirs may face uncertainty or conflict.
• Transfer restrictions and valuation: Fund agreements may restrict transfers or lack valuation mechanisms, complicating buyouts.
• Carried interest treatment: In some cases, a deceased or disabled GP may be forced out of the fund and cashed out at prior valuations, forfeiting potential future gains from unrealized carry.
• Liquidity constraints: Illiquid fund interests can delay estate resolution.

Limited partners (LPs):

LPs in illiquid, drawdown-style funds also face estate planning challenges:

• Delayed distributions: Heirs may inherit fund interests that won't produce liquidity for years.
• Outstanding capital commitments: These can create unexpected financial burdens for beneficiaries.
• Transfer limitations: LP interests are often non-transferable without GP consent, complicating estate administration.
• Emergency liquidity needs: Families may be forced to sell other assets or seek financing to cover expenses or commitments.

To address these risks, insurance planning should be closely coordinated with fund documents to reflect the specific terms of fund agreements, including transfer restrictions, valuation methods and capital obligations.

In many cases, the ownership and beneficiary structure of the policy can significantly impact its effectiveness. For example, establishing a policy within an Irrevocable Life Insurance Trust (ILIT) can remove the death benefit from the taxable estate (applies to new policies only; existing policies transferred to ILITs are subject to a look-back provision), while also providing a clear framework for how proceeds are managed and distributed. This structure is especially valuable when fund interests are illiquid or long-dated, as it allows families to access liquidity without triggering estate tax or disrupting long-term investment positions.

Given that the IPO market remains challenging and additional macroeconomic factors, such as interest rate volatility and constrained access to credit¹, have delayed liquidity events, thoughtful planning becomes even more critical to ensure families are not left financially exposed.

Types of life insurance for tax-aware planning

The simplest and often most affordable form of life insurance is term life insurance, which provides coverage for a specific period and pays a death benefit if the insured passes away during that term. Many PE/VC professionals begin with term insurance early in their careers due to its lower cost and flexibility.

However, this section will focus on permanent life insurance policies, which offer both a death benefit and long-term liquidity through accumulated cash value, features particularly relevant for estate and continuity planning in the PE/VC context.

These policies fall into two broad categories:

Protection-oriented policies include Whole Life and Universal Life, which offer stable cash value accumulation, fixed or flexible premiums and predictable returns. They are often used for estate planning and conservative liquidity needs.

Investment-oriented policies combine life insurance with market exposure, offering the potential for higher returns and greater alignment with broader investment strategies.

• Variable Universal Life (VUL): Allows allocation of cash value across investment sub-accounts, similar to mutual funds. Offers growth potential but requires active oversight and risk tolerance. Unlike whole life, the cash value and possibly the death benefit can fluctuate.
• Indexed Universal Life (IUL): Credits interest based on the performance of a market index (e.g., S&P 500), with upside potential limited by a cap and downside protection via a guaranteed floor. Appeals to those seeking equity-linked upside with limited downside risk.
• Private Placement Life Insurance (PPLI): Designed for high-net-worth individuals, PPLI offers a customizable, tax-deferred investment platform within an insurance wrapper. Key features include:

• Eligibility: Requires accredited investor or qualified purchaser status.
• Investment access: Enables allocation to alternative strategies, such as hedge funds, private equity, secondaries and credit, mirroring the investor's broader portfolio or fund commitments
• Tax efficiency: Investment growth occurs tax-deferred and death benefits are generally income tax-free.
• Strategic fit: Particularly relevant for GPs and LPs seeking to align insurance assets with their existing investment themes while also addressing estate liquidity needs.

Life insurance as a liquidity and continuity tool

One of the most powerful features of life insurance is the immediate, income tax-free liquidity it provides upon death. For PE/VC professionals, this can be critical in covering estate taxes, funding capital commitments and supporting family needs, especially when an outsized portion of the estate is tied up in illiquid fund interests.

In addition to the death benefit, permanent life insurance policies with accumulated cash value can often be accessed during the insured's lifetime through policy loans, which are typically non-taxable if managed properly. While these loans are subject to interest, they can offer flexible liquidity during periods of delayed fund monetization or when other sources of capital are constrained. Keep in mind, for policies that allow for loans, there may be little to no cash value available for loans in a policy's early years.

While policy loans can be a valuable tool, they should be considered alongside other liquidity options, such as HELOCs, securities-backed lines or firm-level credit facilities. Each has trade-offs in terms of cost, access and risk. The key is to evaluate these options in context, ensuring that borrowing decisions align with long-term estate and investment goals.

How proactive planning can make a difference

For private equity and venture capital professionals, proactive planning can help address estate obligations and manage liquidity across illiquid assets. A well-structured strategy can reduce the financial disruption of unexpected transitions and support a smooth transfer of wealth.

As an example, consider a managing partner with significant carried interest and co-investments across multiple funds, each with different liquidity timelines. A three-policy strategy can provide flexibility during life and targeted liquidity at death:

1. Universal Life Policy

Held in an ILIT and designed to maximize the death benefit, this policy provides immediate, tax-free liquidity to cover estate taxes, outstanding capital commitments and other near-term obligations tied to illiquid fund interests.

2. Private Placement Life Insurance (PPLI)

Also held in an ILIT, this policy is funded through annual gifts and invested in strategies aligned with the client's broader portfolio (e.g., secondaries, credit, hedge funds). During life, the cash value can be accessed via policy loans, offering flexibility for managing gated or illiquid assets. While the policy is liquidated at death, access to its value may be delayed depending on the liquidity of the underlying investments.

3. Survivorship (Second-to-Die) Policy

Structured to pay out at the death of the surviving spouse, this policy is often used for wealth transfer and estate tax planning, particularly when the estate tax liability is expected to arise after both spouses have passed.

This kind of layered approach illustrates how strategic insurance design can support both short-term liquidity needs and long-term investment and legacy goals. While PPLI offers powerful tax-efficient growth potential, it should be complemented by traditional policies that ensure timely liquidity when it's needed most.

Final thoughts

Life insurance, when properly structured and integrated, can provide critical liquidity, investment efficiency and continuity. For private equity and venture capital professionals, estate planning must be tightly aligned with the mechanics of fund structures. Trust structures like ILITs should be considered to further enhance these benefits by removing assets from the taxable estate and providing control over how proceeds are used.

To explore how these strategies might apply to your situation, contact your Citizens Wealth Advisor.