Without doubt, the passage of the Pension Protection Act of 2006, which extends the Health Insurance Portability and Accountability Act’s favorable treatment of combination life and long term care policies to combination annuity and LTC contracts, has been one of the most dramatic events affecting the insurance industry in years.
The most compelling implications of the PPA relate to its favorable tax treatment of (1) benefits paid out in case of chronic illness and (2) charges to cover the cost of protection.
As previously discussed, the payment of benefits to cover LTC in an annuity is income tax-free. Now, let’s expand on that.
1. If a contract is a reimbursement contract, in which insureds submit claims and are paid for qualified LTC benefit expenses incurred, then all such payments are truly and totally free of income tax.
2. Other contracts are of a per diem nature, which means that the company pays a fixed monthly (or perhaps daily) benefit regardless of the expenditures actually incurred. For such contracts, the Act, or more precisely, Section 7702B of the Internal Revenue Code, stipulates a per diem rate, which changes annually with the rate of inflation. For 2008, the rate is $270 per day.
For such contracts, assuming a 30-day month, the contract could pay $8,100 monthly on a tax-free basis. Excess amounts payable would be subject to tax.
Further, one cannot buy a reimbursement contract and a per diem contract in order to get potentially an incremental layer of income tax-free benefits. The law will limit the actual tax-free amount in such cases.
3. The Act may lead to greatly increased exchange activity. Let’s assume a variable annuity had been purchased (post-HIPAA) with a $100,000 deposit and now has a value of $400,000. If the annuitant needs to utilize these funds in the current setting, he would have to take withdrawals on a last-in, first-out (LIFO basis), and thus pay tax on dollars needed for care. Effectively, he would have to bump up his withdrawals so that the after-tax value of the withdrawal would cover the LTC expenses.