What is a Long Term Care Annuity?
A long term care annuity is a single premium deferred fixed annuity with a long term care rider that provides enhanced coverage for potential long term care expenses. This type of “hybrid annuity” is designed to prevent destruction of your retirement savings should you require long term care or home health care services.
These annuities with a long term care rider provide double (200%) to triple (300%) your initial single purchase premium in long term care insurance benefit.
If you require long term care services you will select a qualified facility or service provider of your choosing. You will submit receipts and invoices to your insurance company who will direct pay your qualified provider. The benefit is technically a reimbursement benefit meaning you have to pay the cost first and then get reimbursed. However, you do not have to submit the invoices monthly; only initially at the time of claim.
There is a fee to add the long term care insurance rider to an annuity that is charged from your annuity annually. In essence, the cost for the Long Term Care Benefits provided is the opportunity cost of what your money could have earned if it were invested elsewhere.
Long Term Care Insurance Alternatives
Life insurance and annuities with a long term care rider are considered to be a type of asset-based long-term care or otherwise referred to as a hybrid policy. The popularity of Long term care annuities and life insurance with a long term care benefit rider is rapidly increasing, while pure long term care insurance sales continue to decline.
With traditional health-based long-term care insurance, an individual pays insurance premiums over time in order to hedge against the risk of a long-term care event. If the event does not occur, they will receive no benefit from the premiums paid other than the pure insurance value.
Annuities with long term care riders provide long term care benefits and a death benefit to your beneficiary if you do not use the long term care insurance. This certainty is a key difference between traditional long term care insurance and a long term care annuity. Traditional long term care products provide a “use it or loose it” long term care benefit with no death benefit if the insurance is not used. This is one reason why traditional long term care insurance sales have declined and long term care annuity sales are increasing.
Long Term Care Annuity Benefits
A long-term care annuity provides an effective way to protect your assets from the potential expenses associated with end-of-life care. And, it also does so in very tax-efficient ways!
Long term care annuities provide tax benefits thanks to the Pension Protection Act of 2006 (PPA) which further extended the advantages of long term care annuities. The preferential tax treatment of annuities with a qualified long term care rider is intended to increase long term care annuity sales.
Long term care annuities work differently than a traditional fixed annuity. Normally withdrawals from an annuity are taxed using the LIFO (last in first out) method with any gain being taxed as ordinary income. However, withdrawals from a long term care annuity that are used to pay for long term care expenses are income tax-free.
Beneficiaries of a long term care annuity are liable for income taxes on any gain remaining in the contract.
Long Term Care Annuity Example
The below chart is an example of how an annuity with a long-term care benefit works. This sample illustration shows the benefits provided to a 60 year old female purchasing a One America Annuity Care II with $100,000.
As you see the Single Premium is $100,000 (purchase premium) and the LTC Balance is $250,176. The $250,176 is the total amount of LTC Benefit this annuity will provide over a 60 month period.
- 100,000 / 24= $4,169 monthly benefit
- $4,169 x 36 =$150,084 COB Benefit (additional 36 months)
- Premium + COB Benefit = Total LTC Balance $250,084.
(I realize the total long term care balance is about $100 off the illustration below – that is because there is a small amount of interest being credited to the long term care annuity’s account value and I used simple math)
As you can see we’ve added a 36 month COB Rider (continuation of benefits). This annuity is very simple to understand. You take your account value and divide it by 24 to get your monthly LTC Benefit. Your money pays for the first 2 years of benefit and once your annuity account value reaches zero – the COB Rider kicks in to pay the same monthly benefit for another 36 months.
The table below lists the Accumulated value, cash surrender value, LTC total Balance, and COB Annual Benefit for ages 65 thru 100 (using One America’s Annuity Care II).
You’ll notice the account value and long term care benefit balance are barely increasing and that is because today’s interest rates are so low. The annuity’s long term care insurance cost is almost equal to the full amount of interest earned.
I think of it as paying an interest rate commensurate with a short-term certificate of deposit. The only reason to purchase this annuity is to leverage your asset two and a half times for LTC and favorable tax treatment.
If your goal is more geared towards accumulation and not long term care insurance you can view and compare current fixed annuity rates at our online fixed annuity store.
At the time this article was written, there are 14 providers of long term care insurance alternatives. Each long term care annuity works a little differently, but in general, they provide long term care benefits similar to the example provided above.
In a nation with an aging population and a volatile economy, and where end-of-life care and the cost of that care is an ever-increasing concern, understanding the role that asset-based LTC products can play in retirement income planning should be the cost of admission for a financial advisor.
Attorneys, accountants, and financial advisors who work with the elderly often encounter clients who are concerned and confused about LTC. A complete exploration of assets and a thorough knowledge of how long term care annuities assist retirees in funding potential long term care events.
Long Term Care Annuity Underwriting
Qualifying to purchase a long-term care annuity does not require a medical exam or medical records like traditional long-term care insurance. The process is referred to as simplified Underwriting.
Because there is no life insurance death benefit involved the insurance company doesn’t need to underwrite for mortality risk, only morbidity risk. No medical exam required; however, you must be able to answer no to 10 – 12 knock out questions (number varies by insurer and product).
Transfer Your Existing Annuity to a Long Term Care Annuity
Many couples at or nearing retirement age have deferred annuities and permanent life insurance. Often such couples consider repositioning these products without understanding the benefits of ex-changing such policies for asset based LTC policies.
A primary benefit of a long term care annuity is you can exchange an existing annuity to an annuity with a long term care rider using a 1035 exchange with no negative tax consequences.
This can be extremely beneficial if you have an existing non qualified annuity with gain in the contract. You are now able to transfer that annuity to an annuity with a qualified long term care rider and if you use the funds to pay for long term care expenses your withdrawals will come out income tax free.
Long Term Care Annuity Example:
Current Annuity Account Value: $400,000 transferred to long term care annuity using a 1035 Exchange
Current Annuity Cost basis: $200,000 transferred to new Long Term Care Annuity
Current Annuity Gain: $200,000 gain is transferred to new Long Term Care Annuity
Consider an individual, aged 70, owns a traditional annuity with a current account value of $400,000 and a costs basis of $200,000. If withdrawals are made from this annuity to pay for long term care expenses, the $200,000 of gain in the annuity will be taxed at ordinary income rates.
Withdrawals from an annuity with a long term care rider are income tax-free if used to pay for long term care expenses, including home health care expenses.
The below table lists what types policies can be exchanged for an annuity with long term care rider using a tax-free1035 exchange.
SOURCE: Seeking Stable, Efficient Coverage for Long-Term Care with Asset-Based Products
by David A. Gresham, JD, CLU, ChFC. JOURNAL OF FINANCIAL SERVICE PROFESSIONALS | JULY 2016
Long Term Care Annuity Pros
- Leverages your asset 2 to 3 times for a potential long term care need
- IRC Sec. 1035 Exchanges permit you to transfer an existing non-qualified annuity to a long term care annuity
- Under the PPA of 2006, any existing gain built up in your current non-qualified annuity will come out income tax-free if used for Long Term Care expenses. Tax-deferred to Tax-free – The IRS doesn’t allow for many tax planning strategies of this magnitude!
- Simplified Underwriting – since there is no life insurance death benefit involved the insurance company doesn’t need to underwrite for mortality risk, only morbidity risk. No medical exam required; however, you must be able to answer no to 10 – 12 knock out questions (number varies by insurer and product)
- LTC Benefits may be used for home health care as well as nursing home expenses
Long Term Care Annuity Cons
- Requires some underwriting in the form of knock-out questions which means you have to meet certain health requirements to qualify for long term care benefits.
- A long term care annuity does not grow as fast as other types of annuities because the interest earned is used to pay for the cost of the long term care insurance rider.