The aging demographics of the United States together with the Pension and Recovery Act of 2006 (the “PPA”) and the Deficit Reduction Act of 2007 (“DRA”) have provided an excellent planning opportunity to create fiscally efficient vehicles to address clients’ planning needs. Beginning January 1, 2010, a tax-free planning option will be available to individuals who wish to provide long-term health care through the use of an existing annuity or life insurance contract purchased after 1996. who wish to incorporate long-term health care into their estate plan.

Under the provisions of the PPA, annuity funds can be withdrawn completely tax-free on a FIFO (first in, first out) basis for long-term care benefits (as amended by Section 72(e) of the Internal Revenue Code). The PPA also includes a “1035 exchange” option that allows tax-free and penalty-free withdrawal of the full value of the annuity for qualified long-term care expenses. However, no income tax deduction will be allowed for any payment made of 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 (Code Section 213(a)).

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 of all states to adopt “association long-term care insurance plans” under the DRA. Qualified association plans allow an insured to “exclude an amount of assets equal to the value of benefits purchased under a long-term care association policy from qualifying Medicaid.”

Transcendence:

The benefits of converting an existing annuity or life insurance contract include (i) no surrender charge will be applied to account withdrawals for qualified expenses; (ii) withdrawals for qualifying long-term care expenses will be classified as a reduction of tax-free basis; (iii) a spouse may be added to a policy for caregiving purposes; (iv) ten (10%) percent free withdrawal provision for withdrawals from non-long-term contracts; (v) the ability to purchase an optional lifetime provision with guaranteed premiums; and (vi) the annuity cash will continue to be available if the long-term care portion of the policy is never used. However, the conversion will also result in (i) the beginning of a new surrender charge period for the contract; (ii) medical underwriting (at a time when people’s health may be deteriorating); (iii) health care benefits that are limited in scope and a specified number of years; and (iv) the cost of the long-term care rider that reduces the tax-deferred income stream from the annuity. Additionally, the typical 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.

Conclusion:

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 are only used when a person cannot afford or is not interested in comprehensive long-term care insurance.