What is a Long Term Care Annuity?
A long term care annuity is a single premium deferred annuity that combines the safe long term tax deferred growth of a fixed annuity with additional benefits to pay for long term care needs should you need it.
These long term care annuities have two have values; an account value and a long term care benefits value. Your account value grows at a guaranteed rate like any other fixed annuity and your long term care benefits value is anywhere from 2 to 3 times your account value.
If you require long term end of life care your benefits will be based on the LTC Value. Your account value is the amount available to make regular withdraws or as a death benefit – the same way it words on any fixed annuity.
There is a fee associated with a long term care annuity that is built into the annuity contract. A long term care annuity pays a fixed interest rate just like other annuities. The long term care rider fee reduces the interest rate your annuity account value is credited with. The LTC rider fee will never be greater than your credited interest rate so you know that your account value will never go backwards as a result of the LTC rider.
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.
Asset Based Long Term Care
Long Term Care Annuities are considered to be a type of asset based long term care, or otherwise referred to a hybrid policy. Long term care annuities and life insurance with Long Term Care benefits are growing in popularity as viable alternatives to long term care insurance.
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.
An asset-based long-term care product provides a similar hedge against the expense of a long-term care health event, while also paying a death benefit if the retiree does not use all of the long-term care benefit. This certainty of some payout on the policy avoids the pain of loss aversion. It also provides an important non-behavioral benefit of financial risk protection.
Annuity with LTC Rider Tax Advantages
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!
Pension Protection Act of 2006 (PPA).
The PPA extended the preferential treatment of life insurance LTC combination contracts to deferred annuity LTC combination contracts.
With a traditional (non-LTC) fixed annuity, withdrawals are taxed as ordinary income to the extent there is gain in the contract, and gain is deemed to be distributed first. However, the payments made from an asset-based annuity for qualified LTC expenses are income tax free.
Amounts remaining in the contract at the annuitant’s death are ordinary income to the annuitant’s beneficiaries to the extent there is taxable gain remaining in the contract.
• Long-term care benefit payments from the account value are income tax-free as a reduction of basis
• Long-term care benefit payments from the LTC value, or continuation of benefits value, are income tax-free
• The monthly charge to pay for the COB Balance is income tax-free as a reduction of basis in the LTC Account Value. These tax guidelines apply for federal income tax years beginning after December 31, 2009.
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 this number is almost $100 off the illustration below – that is because there is a small amount of interest being credited 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 LTC balance are barely increasing and that is because interest rates are so low right now that the cost of the LTC rider is essentially using all of the interest that is 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 you can view and compare current fixed annuity rates at our online fixed annuity store.
At the time this article was written, there were 14 carriers that market some form of either asset-based life insurance LTC benefits, asset-based annuity LTC benefits, or both, and several more carriers are planning to enter the market. While specifics of the various policies may differ, the general methodology for most of them is based on the same concepts described 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 the options available is required if the advisor is to provide competent advice.
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 benefit with life insurance and annuity policies is that IRC Sec. 1035 permits exchanges from one policy to another policy better suited to meet the needs of the insured. Current regulations also permit partial exchanges of deferred annuity policies with basis being allocated pro rata between policies.
In a gain situation, a proper IRC Sec. 1035 exchange enables the policyholder to postpone the recognition of that gain. The policyholder’s cost basis in the new policy becomes the transferred basis plus any future premiums paid.
Long Term Care Annuity Example:
Surrender value: $400,000 transferred to new policy
Cost basis: $200,000 transferred to new policy
Potential gain: $200,000 tax deferred
Consider an individual, aged 70, who holds a traditional deferred annuity with a current account value of $400,000 and a basis of $200,000. If withdrawals are made from this annuity for expenses, LTC expenses included, the $200,000 gain in the annuity will be taxed first at ordinary income rates.
If the annuity is exchanged under IRC Sec. 1035 for an annuity LTC policy, taxation of the gain will be deferred, and if withdrawals are made for LTC expenses, the distributions will be income tax free.
If this individual wished to allocate half of the $400,000 account value to LTC coverage, he or she could partially exchange half of the contract for an annuity LTC policy. The result after the partial exchange would be two policies: one traditional policy with an account value of $200,000 and a basis of $100,000, and one annuity LTC policy with an account value of $200,000 and a basis of $100,000.
The below table lists what types of tax-free 1035 exchanges are permissible.
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
Pros of a Long Term Care Annuity
- 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