The Pension Protection Act of 2006 became law in January of 2010. The new law offers several provisions to incentivize the purchase of long term care insurance coverage.
One significant component of the new law allows you to use what would normally be taxable annuity dollars to purchase a long term care insurance policy.
This provision can be very useful if you have significant tax-deferred accumulation in a non-qualified annuity and wish to purchase long term care coverage.
First, it is important to realize that Medicare and/or supplemental policies will not pay for extended custodial care for more than a maximum of 100 days. And government run Medicaid will only cover these costs once you have spent down most of your estate.
The Pension Protection Act allows you to use annuity (and life insurance) polices as a tax efficient means to purchase LTC insurance. There are a couple of ways to implement this strategy and it will mostly depend on whether you own an existing non-qualified annuity account.
A non-qualified annuity is one where the invested principal has already been taxed.
The interest (or investment) gains within the annuity have grown on a tax-deferred basis and are only subject to income tax when they are withdrawn.
So long as the account has not been annuitized, then any money that is withdrawn from the annuity would be taxable until all of the growth has first been distributed. Put another way, the gains come out first – not the principal.
However, the Pension Protect Act allows you to withdraw your investment gains tax free in order to purchase long term care insurance. If you invested $100,000 in an annuity and the policy has grown to $120,000 – then you could withdraw the $20,000 on a tax free basis to pay for a long term care insurance policy.
This is a valuable benefit for those who have invested in an annuity account and wish to protect their estate by purchasing long term care insurance. It is important to note however that the new law does not allow for tax free withdrawals from qualified (IRA, 401k) annuities to purchase LTC insurance.
Hybrid annuity policies that include a provision for long term care also benefit from the new law. If you own an existing non-qualified annuity with any tax deferred growth, then you can execute a 1035 tax-free exchange to a new hybrid annuity account.
This exchange will protect the gains in your old, surrendered annuity from income taxes on any level. Your invested dollars will be leveraged two to three times over in the hybrid annuity for long term care benefits. Additionally, any tax-deferred dollars paid out for qualifying care will be tax free.
Hybrid annuity policies are quickly growing in popularity with those who want to maintain control of their assets, but who also want to leverage their invested dollars in the event that extended care is ever needed. Mutual of Omaha and One America/State Life are two companies that are competitive in the hybrid annuity market place.
These plans are also popular as they require less underwriting than traditional LTC coverage and they are easier to qualify for if you have any preexisting conditions or health concerns.
If you don’t already own a deferred non-qualified annuity, then you can still purchase one. You could invest a lump sum in a deferred annuity and withdraw only the interest, on a tax free basis, to pay for a long term care policy. Or you could pay for a long term care policy using an annuitized single premium policy.
If you wish to to have LTCi sooner than later and you don’t want to risk the insurance company declining your application because of health issues, then an immediate, annuitized plan might work best.
Deferred annuities are favorable when the owner can wait several months to a year for their interest to accumulate before purchasing the LTC insurance plan.
An immediate annuity is exactly that; one that begins payouts to the owners almost immediately – usually after only one month, but no longer than one year after the deposit has been made. Thus, an immediate annuity makes systematic payouts of principal and interest each payment cycle.
The principal would not be taxed under any circumstances, but the interest can be taken tax-free so long as it’s used to fund a long term care policy. The payouts can be setup for a set number of years or even a lifetime, but in all cases this method of systematic payments is known as an annuitization.
There are several ways to use an immediate annuity. One strategy is to invest in one that will make systematic equal payments for 10 years and then use those dollars (tax free) to purchase a 10 year paid-up long term care policy.
The annuity payment stream could also be setup for a lifetime. In most cases however, there is no guarantee that your LTC insurance premiums will not increase sometime in the future. This is why some consumers purchase a 10 year paid-up policy.
At any rate, your insurance broker (us) can tell you exactly how much you need to invest in any type of annuity to cover the premiums for your chosen long term care coverage.
People are living longer and medical inflation is extremely high. Governments on all levels are running huge deficits and Medicaid liabilities are a significant reason for their indebtedness.
In response, many states have recently passed laws establishing partnership qualified long term care plans that further add financial incentives to purchase extended care insurance. In a nutshell, many state governments will allow you to protect your estate up to an equal amount of purchased long term care insurance.
That is to say, if you purchase a policy that provides $250,000 in benefits and you end up using the entire amount, then your state cannot legally force you to spend down an additional $250,000 from your estate before Medicaid qualification would be available.
Regardless of the amount of money spent by your insurance policy, Medicaid, and/or your estate – you will have protected at least $250,000 that can be passed on to your beneficiaries.
In summary, federal and state governments are providing much needed tax and planning incentives for those who wish to purchase long term care insurance.
Whether you are using deferred or immediate annuity policies, hybrid accounts, or partnership plans – there are several tax advantaged strategies designed to protect your family and your estate from the exorbitant costs associated with extended care.
Hyers and Associates, Inc is an independent insurance agency specializing in annuity accounts and long term care insurance plans.