LONG-TERM CARE insurance premiums have been rising for many consumers, but financial experts agree that everyone, including the very wealthy, should consider buying coverage. "I consider it portfolio insurance," says Ken Moraif, a certified financial planner and host of the radio show "Money Matters."
Since long-term care expenses can quickly wipe out a person's investments, having insurance can protect assets for future use or heirs. However those who do buy a plan may be in line to receive tax benefits as well. "Purchasing long-term care insurance is one of the few ways the IRS lets you deduct the cost for future care in the current tax year," Moraif says.
Here's a closer look at exactly what tax benefits come with long-term care insurance.
Premiums may be deductible. The greatest tax benefit of these policies is the ability to deduct the premiums, says Amy Danise, insurance editor at NerdWallet.com. However, it isn't as simple as writing off the amount you pay each year. Instead, the government lumps long-term care insurance premiums into health care expenses on itemized deductions.
For most people, if their health care expenses exceed 10 percent of their adjusted gross income, they can deduct the excessive amount. Seniors born before Jan. 2, 1952, can deduct any health care expenses in excess of 7.5 percent of their adjusted gross income in 2016. However, beginning in 2017, seniors will see their deduction threshold jump to 10 percent, just like everyone else.
What's more, there is a cap on how much can be deducted based upon the policyholder's age. For 2016, the limits are as follows:
Age 40 or younger: $390
Ages 41-50: $730
Ages 51-60: $1,460
Ages 61-70: $3,900
Ages 71 and older: $4,870
"This was written quite a while ago," says Leonard Wright, a San Diego CPA and member of The American Institute of Certified Public Accountant's Consumer Financial Education Advocates Group, about the rules surrounding long-term care premium deductions. "It used to cover most of the premium, but now it covers very little."
Benefits are tax-free. In almost all cases, the money paid out by a long-term care insurance policy is exempt from taxes. "In the same way your health insurance or auto insurance would reimburse you, you'll receive long-term care benefits tax-free," says Neil Godsey, managing director with Miracle Mile Advisors in Los Angeles.
Payments can be made from an HSA. Unlike health insurance premiums, payments for long-term care insurance can be made from a health savings account. These tax deductable accounts are only available to those with eligible high deductible health insurance plans. By paying for long-term care insurance out of an HSA, policyholders are effectively getting a tax deduction on the premiums.
Combo products may be different. Bruce Landis, vice president of Providence Advisors Group in Knoxville, Tennessee, has been selling long-term care insurance for nearly 25 years. During that time, he's noticed a trend away from traditional long-term care policies and toward combo or hybrid policies that offer both life insurance and long-term care insurance in one product. "Last year, a majority of our consumers bought the hybrid," Landis says. Combo policies are appealing because they will pay out benefits regardless of whether someone needs long-term care. "They're going to get something back one way or another," Landis explains.
One drawback of the combo policies is they may not come with the tax benefits found with traditional long-term care insurance. Life insurance premiums are not tax deductible, so only the portion paid for a long-term care rider may be eligible for a deduction. What's more, a policy must bill monthly rather than be paid in a lump sum. Godsey advises caution when it comes to expecting a tax deduction from a combo long-term care and life insurance policy. "It's product specific," he says about the potential tax benefits. "When a consumer is looking at these, they need to ask their planner or the company [for guidance]."
1035 exchanges allow for tax-free transfers. Those who have an existing life insurance policy or an annuity may be able to use a 1035 exchange to buy long-term care insurance tax-free. "It's really the only way to get money out of an annuity tax-free," Wright says. For a 1035 exchange to work, the insurance company has to agree to accept money directly from the life insurance or annuity provider. The rules surrounding these exchanges can be complicated, so it's advisable to work with an experienced finance professional.
One catch that can result in taxes. In most, but not all, situations, the benefits of long-term care insurance are tax-free. However, "there is a case where long-term care insurance can be taxable if paid as a per diem," Danise says. These are rare situations in which a policy pays out a flat reimbursement per day, regardless of a person's cost of care. Taxes also apply when the daily payment exceeds a limit set by the government. For instance, in 2016, reimbursement in excess of $340 per day may be taxable.
While the tax benefits of long-term care insurance are nice, Moraif advises against giving them too much weight."Whether it's deductible to you or not should not be the decision point," Moraif says. Instead, everyone should have coverage to guard against long-term care expenses, which have the potential to be financially crippling.