New Tax Rules Affect Long Term Care
By: Kathleen Fowler, Esq.
As of January, 2010, under provisions of the Pension Protection Act of 2006, new tax rules become effective that allow insurance companies to offer combination Annuity and Long-Term Care insurance contracts and combination Life Insurance and Long-Term Care insurance contracts that have clear income tax advantages.
How do these contracts work?
These hybrid contracts combine either an annuity or life insurance contract with a long-term care rider. Each year the premium for the long-term care rider is deducted from the earnings of the annuity or insurance contract. Prior to 2010, these premiums would be taxable to the owner as earnings, but under the new law, the premiums are excluded from the owner’s taxable income.
The new law also clarified the question of whether the benefits, paid to an individual needing long-term care, would be income tax free. The answer clearly now is yes. And, the fact that a long-term care rider attaches to an annuity or life insurance contract will not affect the tax- free nature of the growth in these contracts.
In an annuity long-term care product, the owner uses the annuity portion of the contract first to pay for nursing home care, or in some contracts assisted living or in-home care. Once the annuity is exhausted, the long-term care rider becomes effective. Since the insurance company is not on the hook from the first day that care is needed, the cost of the long-term care rider is less than the cost of a stand-alone contract. Moreover, the earnings in the annuity portion of the contract that are paid out for nursing home care are tax free. In a life insurance long-term care product, the owner uses an accelerated death benefit that is made available to pay for nursing home costs. The death benefit reduces as payments are made. These payments are income tax free, whereas the surrender of a life insurance contract results in taxable income.
Who should investigate these contracts?
Self-insurers: Most stand-alone Long-Term Care contracts contain more benefits than the coverage provided through these combination plans. People planning to self-insure, however, may want to hedge their risk. By contributing to a combination product, the cost of long-term care, if ever needed, is shared by the insurance company. If long-term care benefits are never needed, then the annuity contract or life insurance death benefit is still available to the contract owner or his or her beneficiaries.
Persons who have been denied coverage: Anyone who has been denied coverage may want to explore these contracts, as the underwriting for these hybrid contracts differs from stand-alone contracts. Underwriting for hybrid contracts is more relaxed because the annuity money or death benefit is used first before the long-term care rider comes into effect. With the life insurance long-term care product, the primary underwriting is for the life insurance component where mortality issues are the greater concern. People who are denied long-term care coverage because of a health issue that may require skilled care may still qualify for life insurance and therefore the combination product may be available
In all circumstances, because the terms of these hybrid contracts can be complicated and the benefits offered vary greatly, these contracts should be reviewed thoroughly. Since long-term care products are customized for each person, it makes sense to design a stand-alone contract that mimics the combination product to determine cost effectiveness. By teasing apart the cost of the long-term care insurance from the annuity or life insurance contract, you should be able to determine whether this type of product will make sense for you.
