Considerable interest has been shown in recent years regarding ways of making long term care insurance coverage more affordable and otherwise more attractive to consumers.
Insurers have examined innovative product ideas, how those ideas might fit into existing state and federal regulatory regimes, and consumer goals for protecting against the potentially high LTC costs.
LTC-annuity products offer many attractive features in these regards, but uncertain tax treatment has been a significant practical barrier to product development. A great opportunity exists, however, in pending pension legislation that would eliminate this barrier.
House and Senate conferees currently are working to reconcile different versions of pension bills passed in each chamber. Only the House version includes tax clarifications and enhancements for LTC combination insurance products. However, optimism continues that the market barrier of tax uncertainty that currently exists for LTC-annuity products will be removed from the legislation.
Why is legislation needed in the first place? Good question. The answer lies with the one common feature in LTC-annuity products–the presence of the annuity contract, with its cash values and annuity purchase rate guarantees. That presence raises a number of issues for the LTC coverage under section 7702B(b) of the Internal Revenue Code, which defines a “qualified long term care insurance contract” for tax purposes.
If LTC insurance coverage is provided under a “qualified” contract, benefits generally are received tax-free as accident and health insurance benefits. Section 7702B(b) states, however, that subject to a very narrow exception, qualified contracts may not provide a cash value. Section 7702B(b) also requires qualified contracts to provide insurance coverage only of “qualified long term care services.”
With respect to both requirements, the issue is whether values or coverage associated with the annuity portion of a contract would result in the disqualification of its LTC portion.
Thus, for example, for a contract to be tax-qualified, it would be necessary to conclude that the annuity’s cash value is not part of the LTC portion of the contract. It also would be necessary to conclude that any insurance coverage provided under the annuity (e.g., with respect to annuity purchase rate guarantees) is also not part of the LTC portion of the contract.
The House pension bill resolves these issues by treating the LTC portion of a contract as a separate contract for tax purposes, i.e., the qualification requirements under section 7702B(b) are applied as if the annuity portion of the contract were not there.
Under current law, it has been unclear whether “separate contract” treatment is appropriate for LTC-annuity products. Arguably, the House bill is simply clarifying existing law on this point. (The House bill includes other provisions with respect to combination products that clearly would, however, change existing law.)
If the House bill does just clarify things, then LTC insurance benefits paid from net amounts at risk generally could be received tax-free as A&H insurance benefits.
In contrast, if integrated treatment of the annuity and LTC portions were required, the LTC coverage could not be qualified. Seemingly, then, the LTC benefits would be taxed as distribution from a single, integrated annuity.
The House pension bill not only clarifies that the LTC portion of a contract may be tax-qualified, but it goes further in that it generally treats the entirety of LTC insurance benefits, including amounts coming from annuity cash value, as a tax-free A&H insurance benefit.
Given that such benefits only can be received after the insured is chronically ill and given that they are limited (i.e., they either reimburse actual LTC expenses, or if paid per diem, are subject to caps), this result is entirely proper from a tax policy standpoint. Individuals do not become chronically ill to achieve a tax planning objective. The tax law should recognize that those who come to have LTC costs are confronting an additional health and financial burden–and that insurance benefits used to address that burden do not accrue to the individual’s wealth. Thus, as a policy matter, the House bill’s “separate contract” treatment makes good sense.
Many individuals may prefer a stand-alone LTC contract. However, LTC-annuity combinations offer an attractive and, in many cases, more affordable alternative.