A New Way to Pay for Long-Term Care
Starting this year, thanks to a provision in the Pension Protection Act (PPA), qualified payouts from annuities with a tax-qualified long-term care insurance (LTCi) rider are now income-tax-free. The new tax treatment of these combination or hybrid products has been hailed as one of the most significant events affecting the insurance industry in years.
The new rule dramatically enhances the value of LTCi. For instance, a hybrid annuity contract purchased in 2010 for $100,000 grows to $250,000 over the years. If the insured requires qualified long-term care, he or she can withdraw the entire $250,000 without paying income tax on it. Another provision under the PPA says the $150,000 gain on the original value can be tax-free as well. If the insured needs only a small amount to cover qualified long-term care, the fund will be taken from the principal rather than from any gains.
The favorable tax treatment applies to payments from reimbursement contracts where insureds submit claims and are paid for qualified LTC benefit expenses incurred. These payouts are totally income-tax-free.
For contracts where carriers pay a fixed daily or monthly benefit regardless of the expenditures actually incurred, the Internal Revenue Code stipulates a per diem rate or other periodic basis. For 2010 the limit on the exclusion for payments made is $290 per day. So an insured could collect payouts of $8,700 monthly (assuming a 30-day month) tax-free. Any amount above that is taxable.
People who already own annuities or life insurance can use the 1035 exchange to acquire a hybrid annuity with an LTCi rider without paying any taxes. Basically, the insured switches from a tax-deferred to a tax-free vehicle when funds are used to pay for LTC expenses.
For instance, an annuity holder exchanges an existing variable annuity originally purchased for $100,000 that now has a value of $400,000 for a combo product with a rider that adds $200,000 of LTC protection. All portions of gain paid out from the hybrid contract to reimburse LTC expenses will be income-tax-free.
It is important to note that any existing policy with a death benefit or income guarantee will be forfeited in such an exchange. Any surrender penalty that applies should also be taken into consideration.
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The legal and tax information contained in these articles is merely a summary of our understanding and interpretation of some current provisions of tax law and is not exhaustive. Consult your legal or tax advisor for advice concerning your particular circumstances.
