Beginning with the Health Insurance Portability and Accountability Act (HIPAA) in 1996, individuals could deduct premiums on qualifying LTCI policies for themselves and their dependents on their federal income tax returns. However, two impediments prevent one from taking full advantage of this provision. First, the amount of the eligible premiums is limited by an age-based IRS schedule. Second, the deduction is considered a medical expense, deductible only to the extent total medical expenses in a given year exceed 7.5 percent of one’s adjusted gross income.
Some business owners have found a better answer. A subchapter C corporation can purchase LTCI for its key employees and their spouses and deduct the full amount of the premium as an expense in the year paid. The amount of the expense deductible by the corporation isn’t limited by the IRS eligible premium limits, nor by the individual’s 7.5 percent of adjusted gross income hurdle. Neither the premiums paid, nor the policy benefits when received, constitute income to the key employee.
For a single-owner, single-employee C corporation, paying for LTCI as a business expense is a no-brainer. Even if there are multiple owners or employees, the corporation has a wide degree of latitude on who can and cannot receive this benefit. A typical LTCI benefit plan might apply only to key officers, those who have been employed for a minimum length of time, and so on. Anti-discrimination rules that typically apply to retirement and other health benefit plans don’t apply to LTCI.
The trade association American Association of Long-Term Care Insurance advises that a C corporation can pay and deduct accelerated premiums. Rather than pay LTCI premiums for life, the corporation can elect to make the policy paid-up over a shorter period of time. A “ten-pay” policy, meaning the policy is paid up after 10 years, can be an attractive option. Thus, the C corporation might establish a ten-pay plan that purchases LTCI for managers who reach age 55 and who have been with the firm for five years or more. When those employees reach retirement age at 65, their LTCI will be fully paid up. An added benefit of the accelerated premiums is that once the premium payment period has been completed, the insurer can no longer raise the premiums.
Let’s shift from paying for LTCI as a deductible business expense to combining LTCI with life insurance products. It’s commonly said that people are loathe to pay for insurance they don’t think they’ll need. Typical examples are disability insurance and, of course, LTCI. With life insurance, everyone understands they’re going to die, but that at least one’s heirs will get some benefit from the policy.
Now let’s look more closely at combining LTCI with insurance products such as cash-value life insurance and deferred annuities.
For some years now, it’s been possible to purchase cash value life insurance with a rider that provides tax-free withdrawals to pay for long-term care. Under the 2006 Pension Protection Act, withdrawals from qualifying annuities to pay long-term care expenses became tax-free beginning January 1, 2010, provided the policy contains the appropriate language. Older life insurance policies and variable annuities typically don’t provide long-term care benefits, but either can usually be exchanged tax-free under Internal Revenue Code Sec. 1035 into new life policies or annuities that provide linked benefits covering long-term care expenses. An important difference between using life insurance and annuities to provide linked long-term care benefits—life insurance usually requires underwriting (a health exam), while annuities usually don’t.
As a simple annuity example, consider the following from the trade publication Life & Health National Underwriter. A 60-year-old person deposits $100,000 into a single premium deferred annuity (SPDA) having a stated crediting rate of 4 percent. The SPDA has a rider that provides long-term care benefits of up to two times the account value. The rider costs 65 basis points a year (0.65 percent), charged against the accumulating account balance. According to Mike Schlegel, the average long-term care policy claim begins around age 80 and lasts four years. In our example, at age 80, the annuitant’s account has grown to $193,000, providing a potential $386,000 in long-term care benefits. Over 48 months, this equates to $8,041 per month, or $268 per day, tax-free.
If no long-term care claim is made, the full amount of the annuity is available to meet other living expenses, or may be passed on as a legacy. Annuity withdrawals not used to pay for long-term care are taxable as ordinary income, either to the annuitant or the heirs. If life insurance is used in a linked benefit approach, the policy proceeds remain income tax-free at death, regardless of whether any portion of the death benefits is withdrawn to pay for long-term care.
Whether using long-term care riders attached to life insurance or deferred annuities makes sense for a particular individual is a complicated question. If you wish to explore this avenue, you should consult a highly qualified insurance person and confirm the tax impact of your plan with your tax preparer. No one ever said growing old was fun, but having Uncle Sam pay for some of it may be very appealing.
