New Tax Breaks Make Long-Term Care Packages More Appealing
If you’ll need to go into a nursing home some day or hire a caregiver in your own home, you’ll probably have to pay substantial amounts. (For more information on the costs of long-term care, please see the article “Higher Costs for Long-Term Care” in the December 2009 issue of CPA Client Bulletin.) Long-term care (LTC) insurance policies are available, but many people are reluctant to buy this coverage.
Fortunately, several provisions of the Pension Protection Act of 2006 just took effect in 2010; they can make it more practical to obtain LTC insurance by combining it with life insurance or an annuity.
Use it or lose it Depending on the level of coverage you select and how old you are when you buy an LTC insurance policy, you might pay more than $2,000 a year. Married couples could pay over $4,000 to cover both spouses. That’s a considerable expense for many people, especially retirees who are living on a fixed income.
Moreover, you’ll pay those thousands of dollars without a guarantee that you’ll get any benefits from your LTC insurance. Some seniors use little to none of their long-term care benefits during their lifetimes. Paying steep premiums for an LTC insurance policy you’ll never use is less than desirable. You may wish to look for another type of coverage.
Combination coverage
As an alternative to a “straight” LTC policy, you can obtain LTC coverage as an addition to your life insurance policy. That way you’ll know that at least someone will benefit from the premiums you pay.
Example 1: Steve Clark buys a $500,000 insurance policy on his life, payable to his two children. He chooses to add an LTC rider to this policy. If Steve needs care, the policy will pay a benefit to help him with the cost. However, such payments probably will reduce the death benefit that Steve’s children eventually will receive.
If Steve never needs long-term care, his children will receive the life insurance policy’s full death benefit when he dies. Therefore, the premiums that Steve pays for this policy eventually will generate a payout. You also can buy a deferred annuity with an LTC rider. A deferred annuity is an investment that can earn income but delays income tax until you withdraw money.
Example 2: Janette Rogers invests $100,000 in a deferred annuity and selects an LTC rider.
As is the case with all deferred annuities, any earnings on that $100,000 will not be taxed until Janette takes money from the annuity. The LTC rider will pay Janette a benefit if she needs care; however, such payments will reduce the amount of money available to Janette as an annuity.
If Janette does not need longterm care, she will be able to tap the full amount of the deferred annuity for living expenses. Depending on the choices Janette makes with her deferred annuity, her beneficiaries may receive a benefit upon her death. By choosing an annuity/LTC insurance combination product, Janette gets LTC coverage along with the assurance that her premiums ultimately will deliver a financial benefit.
Delayed gratification
Life insurance/LTC insurance and annuity/LTC insurance combination products have been around for a while. They were enhanced by several of the recently effective tax provisions of the Pension Protection Act of 2006.
- Annuities with LTC riders are explicitly recognized in the tax code. Previously, the tax benefits of life insurance/LTC policies were spelled out but annuity/ LTC combinations didn’t garner the same recognition. The new law makes it clear that annuities with LTC riders can make tax free payments for coverage under the LTC rider.
- Internal cash transfers can be tax free. In many of these combination products, you pay a premium for the life insurance policy or the annuity, and then the company makes a bookkeeping entry that pays for LTC coverage. Under prior law, you might have been taxed as though money had been withdrawn from the life insurance policy or annuity. The new law removes the tax on such phantom income.
- LTC insurance joins the 1035 club. For many years, Section 1035 of the tax code has allowed consumers to make tax-free exchanges of life insurance policies and annuities. Now, LTC insurance policies also are on the list.
Example 3: Phil Allen owns a deferred annuity that he no longer needs. Phil can exchange this annuity for an LTC insurance policy. To effect the exchange, Phil can apply for an LTC insurance policy. Once the LTC insurance company approves Phil’s application, he can transfer his annuity to the LTC insurer, which will surrender the annuity and use the money it receives to fund the LTC insurance policy. Phil won’t owe tax on any earnings accumulated within the deferred annuity.
The new law allows an exchange into an LTC insurance combination product or a policy that provides only LTC insurance. Either way, you’re using money that you’ve already spent to buy LTC coverage.
All LTC insurance products can be complex. Combining them with life insurance or annuities may make them even more difficult to understand. If you are interested in LTC coverage, working with an experienced insurance agent is a good idea. Our office can help clarify the costs and possible benefits of a particular policy while reviewing the impact of the new tax provisions.
Trusted Advice
Long-Term Care Qualifications
- The new tax benefits for longterm care (LTC) insurance are available only if the policy is “tax-qualified.”
- To be tax-qualified, a policy must pay benefits only when a licensed health care practitioner asserts that at least two activities of daily living (ADLs) can’t be performed without substantial assistance.
- ADLs include eating, bathing, dressing, getting in and out of beds and chairs, and using the bathroom.
- For people who can perform their ADLs, an LTC policy may be tax-qualified if it pays benefits in cases of severe cognitive impairment.
- The conditions requiring caremust be expected to last for at least 90 days.
- Most LTC insurance policies now sold are tax-qualified.
