In 2015 the IRS will once again increase the amounts long-term care insurance customers can deduct from their federal income taxes. Premiums for tax-qualified policies, which comprise the vast majority of the long-term care insurance market, are deductible as medical expenses as long as total medical expenses exceed 10 percent of an under-65 taxpayer’s adjusted gross income. For seniors 65 and older, medical expenses must exceed only 7.5 percent of income to qualify for the same deductions.
The increases in deductibility limits from 2014 to 2015, respectively, are $370 to $380 for taxpayers 40 or younger; $700 to $710 between ages 40 and 50; $1,400 to $1,430 between ages 50 and 60; $3,720 to $3,800 between ages 60 and 70; and $4,660 to $4,750 for anyone over 70. The IRS also changed its rule regarding per diem policies so that benefits are not included in the adjusted gross income calculation until they exceed either the beneficiary’s total qualified long-term care expenses or $330 per day.
These increases may not have as much an effect as long-term care insurance (LTCI) customers would like, however. LTCI deductions have only been legal since HIPAA came into effect in 1997, and at that time their deductibility at first applied to a relatively narrow set of policies. Written into the law was a provision that benefits received from LTCI policies would be tax-free, and that premiums would be tax-deductible – but only for tax-qualified plans. “HIPAA brought about standardization in the industry,” said Stephen D. Forman, Long-Term Care Associates Vice President. “In return for consumer protections of qualified long-term care plans, the benefits received from qualified policies were to be received tax-free.”
This provision led the vast majority of insurers in the long-term care market to tax-qualify their policies by incorporating HIPAA’s language regarding eligible, “chronically ill” individuals: “An individual is chronically ill if…He or she is unable to perform at least two activities of daily living without substantial assistance from another individual for at least 90 days, due to a loss of functional capacity.”
While these changes did lead to the greater numbers of tax-qualified policies we see today, most LTCI customers still don’t benefit much from increases in deductibility limits. “You have to be someone who itemizes your expenses, and most people don’t,” said Forman. Even for those who do itemize, the standard deduction may still provide for greater savings compared to the combination of itemization and LTCI premium deductions. And finally, deductibility increases won’t affect LTCI customers who don’t exceed the 10 percent limit of gross adjusted income.
If recent trends continue, additional legislation won’t likely change the situation, either. “Just about everyone in the industry has acknowledged this deductibility is not persuading many people,” said Forman, “but rather than making deductions easier to obtain – thus making the purchase of LTCI more attractive—the federal government raised that lower income limit from 7.5 to 10 percent, making it so even fewer people qualify for the deduction.”
Still, there are better ways to make long-term care a more affordable option. “An HSA [health savings account] is a very good way of paying for long-term care premiums,” said Forman. For clients who can’t deduct their premiums as self-employed people, or who can’t claim them as unreimbursed medical expenses, tax-qualified dollars from an HSA makes LTCI much more feasible. To take advantage, an individuals must be covered by a high-deductible health plan, cannot be covered by a non-high deductible health plan and must put the HSA dollars towards a premium for a tax-qualified LTCI policy.
Owning a business also makes it easier for clients to deduct LTCI premiums in a way that benefits both employer and employee. Owners of sole proprietorships, S-Corps, LLCs and Partnerships can deduct the full premiums of the qualified LTCI policies they purchase for their employees, as well as the eligible premium amounts for the policies they purchase for themselves, their spouses and their dependents. “This is why work site marketing of LTCI pans has really exploded over the last 15 years, and it’s only decelerated recently because carriers are leaving the market,” said Forman.
Overall, the IRS’s premium deductibility limits may assist some clients, primarily those who itemize their medical expenses and stand to gain more from premium deductions than the standard deduction. For other retirees and pre-retirees, an HSA or business-enabled full premium deduction may save far more money in the long run. Given the overwhelming need for long-term care among retirees, and its high out-of-pocket costs, advisers should analyze each of these options before making the case for LTCI to their clients.