Section 844 was recently activated to boost LTCI sales: Will it work?Article added by Roccy DeFrancesco on January 12, 2010
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I wanted to let everyone know of a law change that was passed in 2006 with the Pension Protection Act (PPA), but didn't go into effect until January 1, 2010. Why do you need to know about this law change?
The government knows it can't keep paying for LTCI for all seniors (Medicaid is a disaster). Therefore, laws have been passed to help Americans buy LTCI coverage. What's the problem, though? LTCI insurance is extremely expensive, and most clients don't want to buy it because they think of it as they do term life insurance -- if you don't use it, it's a waste of money.
Section 844: Treatment of annuity and life insurance contracts with a long term care insurance feature
The above is the official title of Section 844, and it certainly sounds interesting. Essentially, Section 844 has the following benefits:
1) It allows LTCI benefits from annuities and life insurance policies to pay income tax free (so long as the benefits are tax qualified).
Annuities with LTCI benefits
2) It allows for the 1035 exchange of a life insurance policy or annuity to a LTCI policy.
3) 3) It allows for the 1035 exchange of an annuity that does not have a LTCI rider to one that does have one.
Did you know that there are annuities with real LTCI riders? (If you would like information on annuities that have LTCI riders, please contact me using the forum below). If you buy one and never need the LTCI benefit, you have an annuity with cash you can use in retirement. However, if you need the LTCI benefit, you have it. The problem with these annuities is that, prior to January 1, 2010, the LTCI benefit was taxable, as well as potentially the payment of the premium allocated to the LTCI benefit.
Section 844 changed that, and now benefits from an annuity with a LTCI rider are income tax free (provided that it is a "tax-qualified" benefit and not one owned in a qualified plan) as well as the premium payments made inside the policy from the cash value.
1035 exchanging annuities
There is an interesting opportunity when 1035 exchanging an older annuity that did not have a LTCI benefit to one that does. Think about it. What if you have a client who has an annuity with a $50,000 basis and a cash surrender value of $150,000? If the client takes money from the annuity, he/she is going to have to pay income taxes on all the gains. If the client had no LTCI policy in place, it is likely that some or much of the
However, if the client 1035 exchanges the annuity to one with a LTCI benefit, all of the money in the annuity could then be used in retirement to pay for LTCI expenses. This is very significant, and many clients who have this fact pattern should jump at the chance to convert a tax hostile annuity to one that could have the benefit completely tax free.
While the above sounds very beneficial, the law states that the tax-free benefit received by the policyholder will reduce the client's basis in the annuity. Using my earlier example, if the client took $50,000 from the annuity to pay for LTCI expenses, the basis in the annuity would be reduced by $50,000. Therefore, if the client needed cash from the annuity that would be used for other non-LTCI benefits, all such withdrawals would be income taxable.
So, if the client uses the vast majority of the money from the annuity to pay for LTCI expenses, it's a good deal. If not, it may be a wash from an income tax saving point of
Insurance companies must have seen the writing on the wall with this subject, and have made Section 844 nearly obsolete (except the above example and funding an annuity from scratch that has a LTCI rider).
As many of you know, throughout the last few years, many insurance companies have rolled out life insurance policies with what we call "accelerated benefit riders" (ABRs) (governed under Section 101(g)(1) of the IRC).
An ABR is when the insurance company agrees to pay an insured a portion of the death benefit (DB) prior to death due to certain qualifying events. A qualifying event typically is when an insured cannot perform two of six ADLs (similar to a LTCI policy trigger). Because the DB is being accelerated, it is not technically a LTCI benefit and is paid income-tax-free. Therefore, Section 844 is not needed to allow this benefit to be paid tax free.
Terminal and critical illness riders
As many of you know, my favorite wealth-building cash value life insurance policy (Revolutionary Life) has a "free" LTCI benefit built into the policy as well as a "free" rider for critical and terminal illness. The terminal illness rider will pay the insured 85 percent to 95 percent of the DB.
Single premium life insurance policies
SPL policies are very popular today. Why? Because these policies have a significant LTCI benefit and are a terrific alternative place for a client to place money that normally sits in CDs or money market accounts.
Why did I write an article about Section 844? Because it went into effect on January 1, 2010; and if you are in the financial services, tax, or estate planning field(s), you need to know this law is on the books and active (and you want to look for the client who has a low basis annuity that can be 1035 exchanged to a new one that has a LTCI rider).
Why else did I want to write this article? To remind all advisors how important it is to know the products in the marketplace that have LTCI benefits, many of them with "free" riders. It is my opinion that if you are not offering your clients products (life and annuities) that have LTCI benefits, you are running the risk of lawsuits.
Would your clients rather buy a cash value life policy with or without a free LTCI rider? Would they rather buy an annuity that has an income rider that will increase by 3 percent if they can't perform two of six ADLs?
Would your clients rather let their money sit in CDs/MM accounts or grow in a SPL policy tax deferred at better rates and receive a LTCI benefit they are not receiving currently?
Finally, I want to wish everyone a very merry and prosperous new year and look for many exciting and useful items to come from my articles in 2010.
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