Common Features of an Annuity with a Long-Term Care Rider
An Annuity with a Long-Term Care Rider starts with an annuity foundation. Meaning that the underlying policy has cash value. If you die, generally this cash value will pass as a death benefit to the beneficiaries that you name on the policy.
The long-term care rider will typically create a pool of funds that you can draw off of for long-term care expenses. Usually, the long-term care benefit pool of funds is larger than your cash value in the policy (often 2-3 times larger). If you draw long-term care benefits, your cash value will usually be depleted dollar for dollar. Thus, if you’ve depleted your cash value, there will still be funds remaining in your long-term care pool to pay for care, but if you die, there will no longer be any cash value remaining and therefore no benefit will paid to any beneficiaries. The rate at which you can draw funds from the long-term care pool is typically subject to a monthly cap.
Let’s look at a very simplified example: If your annuity with long-term care rider has a cash value of $100,000, it may have a long-term care benefit pool of $300,000 that you can draw up to $10,000 per month for long-term care expenses. If you use $70,000 of long-term care benefits during your lifetime, then there would still be a remaining cash value of $30,000 that would pass as a death benefit to your beneficiaries. However, if you use $200,000 of long-term care benefits during your lifetime, your cash value will be gone and there will not be a death benefit to your beneficiaries.
As is the case with most life insurance and annuity policies, there may be different riders or options that you can add to the policy for an added fee. For example, some policies offer the option to pay an additional annual premium to increase the long-term care benefit pool.
Tax Benefits Under the Pension Protection Act
On August 17, 2006, the President signed into law the Pension Protection Act of 2006 (PPA). And as you might imagine from the title, the bulk of the PPA relates to pension plans. However, buried within the PPA were some provisions that added tax benefits to using annuities for long-term care planning purposes.
Individuals who currently own annuity contracts can transfer old annuity policies for new annuities that include long-term care riders with special tax advantages. The PPA allows the cash value of annuity contracts to be used to pay premiums on new annuities with long-term care payment provisions.
In addition, the PPA allows annuity contracts without long-term care riders to be exchanged for contracts with such a rider in a tax-free transfer under Section 1035 of the Internal Revenue Code (IRC) of 1986, as amended. This provision may prove beneficial to individuals who own annuities with a large cost basis and those who are not in the best of health.
Finally, when the new PPA-compliant annuity is used to pay for care, the money paid out of the annuity is tax-free.
All of these benefits create powerful tax advantages. If you have an older annuity with low tax basis, you probably weren’t planning to touch it anyway (annuities are taxed last in, first out, meaning that all of your gains come out of the policy first and will be taxed). You can now leverage this old annuity into a new annuity with a long-term care rider. If you end up needing long-term care, you’ll then be able to pull money from the annuity tax-free to pay for your long-term care needs.
Benefits of an Annuity with Long-Term Care Rider
Compared with traditional long-term care insurance, an annuity with long-term care rider offers the following benefits:
- Premiums are guaranteed—meaning that they cannot increase in the future. You know exactly what to expect and can budget accordingly.
- If you don’t need care or only need a little bit of long-term care, then the remaining cash value will be paid to your family so it’s no longer a “use it or lose it” proposition.
- Interest rates paid on the cash build up in the policy usually are comparable to or will exceed returns received in a low-yield account such as a Certificate of Deposit.
- You can purchase a policy with a guaranteed return of premium feature if you have concerns about getting your money back (though of course if you trigger this, you’ll no longer have long-term care coverage).
- It allows you to leverage a portion of your retirement portfolio to create a long-term care benefit pool.
- It can be a tax-efficient way to pay for long-term care expenses.
- More flexible underwriting. Even if you have medical conditions that disqualified you from a traditional long-term care insurance policy or a life insurance policy with long-term care rider, you may still qualify for an annuity with long-term care rider. Some annuities with long-term care riders have quite minimal underwriting requirements.
Case Study: Bob, Age 70
Let’s take a look at an example. Bob is 70 years old and recently widowed. His children live out of town and are very concerned about what would happen if Dad needed some additional care in the future. Bob has some health concerns. He was recently diagnosed with diabetes and he has a history of heart disease. As a result, he was declined traditional long-term care insurance.
Bob has a fixed annuity. He has paid $100,000 in premiums in to the annuity and overtime, it has grown to be worth $200,000. One option might be for Bob to exchange his existing annuity for an annuity with a long-term care rider. His $200,000 cash value in the old annuity would get rolled into a new annuity with a long-term care rider.
Potentially, the long-term care rider may create a long-term care benefit pool of $600,000. Bob can draw up to $8,333 per month from the long-term care benefit pool to pay for long-term care expenses. If he does so, the funds will come out of the annuity tax-free. This gives him the power to pay for 72 months of care tax-free! If he had just used the $200,000 to pay for care, it only would have lasted about 24 months AND he would have had to pay taxes on the gain in the old annuity.
We Can Help You Develop a Long-Term Care Plan
Having assisted many Wake County clients with long-term care planning, our team at Carolina Family Estate Planning understands that developing a long-term care plan is about not just protecting your own independence and dignity, but also protecting those you love from the physical, emotional, and financial toll that caring for a loved one can take.
We’ve helped many clients take an interdisciplinary approach to their long-term care planning by exploring both legal and financial options. Usually, a well-rounded long-term care plan will involve a combination of legal, health care, and financial tools to meet your goals and maximize your protection. To get started, register an upcoming seminar to learn more or call our office at 919-443-3035.
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