When buying a
long-term-care insurance policy, consumers typically focus on benefit payments,
features and cost. An issue that’s
often overlooked but that needs to be examined early on is whether the policy
qualifies for federal and, in some cases, state tax deductions.
issue tax-qualified and non-qualified versions of a Long-Term Care (LTC)
insurance policy. Many advisors consider the tax benefits of the tax-qualified
policy essential, in part because it is what makes LTC policies affordable for
many buyers. Others contend that the
non-qualified versions not only are less restrictive than qualified policies,
but can still qualify for some tax benefits.
(Some companies allow policyholders to convert their tax-qualified plan
to a non-qualified plan.) The decision
as to which type of policy to choose is compounded by the fact that the
Internal Revenue Service has not ruled on this tax-deductibility issue.
Under a 1996
federal law, all LTC policies issued before 1997 are treated as tax-qualified
as long as they met state standards at the time. Plans issued in 1997 and later must meet standards described in
the 1996 act in order to qualify for tax benefits similar to those for major
Some of the
standards focus on consumer protection.
For example, tax-qualified plans must provide specific information that
allows the consumer to easily compare competing policies. The plans generally cannot exclude certain
medical conditions, with some exceptions.
And the insurance company cannot cancel a policy except for nonpayment
of premiums, and even that cancellation is restricted.
tax-qualifying standards address specific policy features. A key feature is what triggers benefit
payments. One trigger involves the
inability to perform without substantial assistance at least two of six
activities of daily living (ADLs): bathing, continence, dressing, eating,
toileting and transferring.
Furthermore, a doctor must certify that the person is unable to perform
two or more ADLs for at least 90 days.
also may be triggered if the person requires substantial supervision due to
“severe” cognitive impairment, such as Alzheimer’s disease.
A policy that
doesn’t qualify for favored tax treatment is one that includes “medical
necessity” as a trigger or the inability to perform only one of seven
ADLs (ambulation may be included, which may provide for coverage sooner than
the others). And the cognitive
impairment trigger does not have to be “severe.” (If you buy a non-qualified plan, you must sign a disclosure
statement acknowledging that the plan is non-qualifed.)
Why be concerned
about the tax issues, especially if a non-qualified plan potentially is less
restrictive? Two reasons.
First, with a
tax-qualified plan you can deduct a portion of the cost of your premiums,
depending on your age and your overall medical expenses. For tax year 2002, a
person age 51–60 can deduct $900, while someone 71 or older can deduct
$2,990. This deduction amount is
included with your other medical deductions for the year, and only the amount
of your total deductions that exceed 7.5 percent of your adjusted gross income
qualifies for an actual deduction. (The
self-employed may qualify for additional premium deductions.)
paid out from tax-qualified LTC plans generally are not subject to federal
income tax (21 states also exempt the benefits from tax). The exception is indemnity plans, which pay
a set amount per day, regardless of what the care actually costs. For 2002, any daily indemnity payout above
$210 (adjusted annually for inflation) is subject to federal income tax, unless
that additional payout goes to pay for qualified LTC services.
Many experts agree that
the premiums paid into non-qualified plans don’t qualify for a tax deduction,
but they see that as a less crucial issue because the dollar amounts are not as
significant. The more important issue
is whether the benefits paid out are taxable as income. Benefit payouts can easily amount to $50,000
or more a year, and the custodial expenses do not qualify as a deduction to
offset that income, so taxability is a significant issue.
guidance, taxpayers and their financial advisors are on their own. Many advisors and taxpayers don’t treat the
benefit payments as taxable income.
Other advisors caution that individuals should stick with qualified
plans, even if they are more restrictive because of the potential tax
For further information about Long-Term Care policies, call
Diane M. Pearson, CFP™ at (412) 635-9210 extension 20.