The aging demographics of the United States coupled with the Pension and Recovery Act of 2006 (the "PPA”) and Deficit Reduction Act of 2007 (“DRA”) have provided an excellent planning opportunity to create tax efficient vehicles to solve a clients’ long-term care planning needs. Beginning on January 1, 2010, a tax-free planning option will become available for individuals who desire to provide for long-term medical care by utilizing an existing annuity or life insurance contract purchased after 1996. While not a new concept (it dates back to 1997), the 2010 tax-free planning opportunity may be beneficial to an individual with a larger than needed life insurance policy death benefit, unaffordable monthly or annual premiums, an under-performing or matured deferred annuity contract, or the desire to incorporate long-term medical care into his or her estate plan.
Under the PPA provisions, annuity funds may be withdrawn completely tax-free on a FIFO (First-in, First-out) basis for long-term care benefits (amending Section 72(e) of the Internal Revenue Code). The PPA also includes a “1035 exchange” option which allows for the tax-free and penalty free basis withdrawal of the entire annuity value for qualified long term care expenses. However, no income tax deduction will be allowed for any payment made from the cash surrender value of a life insurance contract or the cash value of an annuity contract for coverage under a qualified long-term care insurance contract (Section 213(a) of the Code).
This benefit is further enhanced by the modification of the Medicaid “look back” period from thirty-two (32) months to sixty (60) months for transferred assets, and the authority for all states to adopt “partnership long term care insurance plans” under the DRA. The qualified partnership plans allow an insured to “exclude an amount of assets equal to the value of the benefits purchased in a long-term care partnership policy from Medicaid qualification.”
The benefits of converting an existing annuity or life insurance contract include (i) no surrender charge will apply to account withdrawals for qualifying long-term care expenses; (ii) withdrawals for qualifying long-term care expenses will be categorized as a tax-free reduction of basis; (iii) a spouse can be added to a policy for long-term care purposes; (iv) ten (10%) percent free withdrawal provision for non-long term contract withdrawals; (v) the ability to purchase an optional lifetime long-term care provision with guaranteed premiums; and (vi) the annuity’s cash will remain available if the long-term care portion of the policy is never utilized. However, the conversion will also result in (i) the commencement of a new surrender charge period for the contract; (ii) medical underwriting (at a time when the individuals health may be declining); (iii) health care benefits that are limited in scope and to a specified number of years; and (iv) the cost of the long-term care rider reducing the annuity’s tax-deferred income stream. In addition, the typically policy will contain a two-year waiting period from the time the annuity is purchased before benefits can be activated and a 90-day “elimination period” once a claim is filed.
A hybrid policy of this nature should not be used as a substitute for comprehensive long-term care insurance. It is recommended that these policies only be utilized when an individual can’t afford or is uninterested in comprehensive long-term care insurance.
Marc J. Soss, Esquire practices in the areas of estate and tax planning; probate, trust and guardianship administration and litigation; and corporate law in Southwest Florida. Marc has published numerous articles and been quoted in the Forbes.Com, Fox Business, Naval Reserve Association Magazine, Rhode Island Bar magazine, Bradenton Herald, Lawyers USA, and Military.com.