Fixed Annuities

How Fixed Annuities Can Be Used to Cover the Long Term Care Risk

While annuity products have been used for years as a funding vehicle to pay Long Term Care Insurance premiums, the Pension Protection Act of 2006 now allows use of a non-qualified annuity to pay for Long Term Care Insurance premiums tax-free (beginning 1/1/2010). New annuity products also have emerged combining Long Term Care benefits into one contract.

1035 exchanges under Pension Protection Act of 2006

Fixed non-qualified annuities -- contracts funded with after-tax money and from a source other than a qualified retirement plan -- now offer additional tax advantages when used to fund Long Term Care Insurance premiums through a Section 1035 exchange. For background, a 1035 exchange is the replacement, or exchange, of an annuity or life insurance policy without tax consequences. Prior to the Pension Protection Act, the allowable types of exchanges included from an old life insurance policy to a new life insurance policy, from an old life insurance policy to a new annuity, and from an old annuity to a new annuity. (Note: An old annuity cannot be exchanged for a new life insurance policy.)

You may be able to take advantage of a 1035 tax-free exchange to fund your Long Term Care Insurance policy premiums. In a 1035 exchange from a non-qualified annuity into a Long Term Care Insurance policy, the gain in the annuity contract will be reduced pro-rata with the amount of total gain in the contract. For example, if the annuity had accumulated enough gain to account for 40% of the account value, then withdrawals to fund Long Term Care Insurance premiums would be taken as 60% from the original annuity investment and 40% from gain. This type of exchange is tax-free to you, and depending on how much the annuity has grown over time and your specific tax bracket, the tax benefit could be quite meaningful.

Unless IRS issues instructions requiring different reporting, the income from a non-qualified Single Premium Immediate Annuity may be reported as a tax-free 1035 exchange. Payments are considered a full or partial irrevocable assignment of the annuity contract, and at least one major carrier already is reporting these Single Premium Immediate Annuity payments with no taxable amount (provided that the payments are directly funding traditional Long Term Care Insurance).

Annuity/Long Term Care Insurance Combination Products

Beginning 1/1/2010, any consumer holding a non-qualified annuity can move funds tax-free to an Annuity/Long Term Care linked benefit product via a 1035 exchange. Prior to this date, Long Term Care benefits and contract charges paid from a linked benefit product were taxable.

The specific changes as of 1/1/2010 are that a Tax Qualified LTCI (QLTCI) rider under a non-qualified annuity contract will be treated as a separate contract, thus QLTCI benefits paid from these riders are tax free; and LTCI rider charges against the account value are not a taxable distribution, although they reduce the client's cost basis (but not below zero).

Annuity/Long Term Care linked benefit products are especially appealing to consumers who understand the Long Term Care risk, but so far are self-insuring due to the use-it-or-lose-it nature of traditional Long Term Care Insurance. With linked benefit products, the account funds can be used to pay for Long Term Care, should those expenses arise; and further the maximum Long Term Care benefit can be leveraged as a multiple of several times the annuity's fund value. Since the fund value itself is drawn down first for Long Term Care expenses, the cost of having Long Term Care protection is much less under the linked design compared to traditional Long Term Care Insurance premiums.

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• Deferred Annuities vs. Immediate Annuities
• Annuity Premiums
• Options for Taking Annuity Payments (Annuitization)
• Annuity Charges and Fees
• How Fixed Annuities Can Be Used to Cover the Long Term Care Risk