In recent years, some insurers have begun to offer long term care insurance (LTCII) coverage in the form of riders to life insurance policies. These riders are often referred to as "living benefit" or "living needs" riders. The LTCI benefits offered under these riders are similar to those found in an LTCI policy. The benefits may be defined as a specific daily amount or as a percentage of the face amount of the policy (up to a specified maximum). Under an "independent" program, the LTCI rider will not affect the policy's death benefit (or cash value), but in an "integrated" program, any LTCI rider benefits paid will result in a reduction of these values.
LTCI policies (including LTCI riders) come in two base models: reimbursement plans and indemnity plans. A reimbursement plan pays the selected benefit, but only up to the actual cost of the service. In contrast, an indemnity plan pays the selected benefit amount -- even if it exceeds the actual cost incurred. An indemnity plan provides more flexibility, but is also more expensive.
In deciding whether to buy a stand-alone LTCI policy or an LTCI rider to a life insurance policy, the purchaser should consider the following issues:
- Is there a need for the life insurance coverage?
- Will the LTCI coverage be adequate, particularly where the carrier caps the amount that can go to LTCI benefits as a percentage of the face amount of the policy?
- If LTCI benefits are paid, will the reduced life benefits (under an integrated plan) be sufficient for the beneficiaries?
- Are the benefit options in an LTCI rider comparable to those in a stand-alone LTCI policy?
- How much more expensive is the cost of a stand-alone LTCI policy compared to an LTCI rider?
An analysis of LTCI insurance policies is beyond the scope of this article, but let's assume that the decision is made to purchase a life insurance policy with an LTCI rider. Let's further assume the insured has a taxable estate and, therefore, wants the life insurance policy to be owned by an irrevocable life insurance trust (ILIT). How best to structure this program for a married couple?
The insured will be the grantor and the insured's spouse (or child) will be the trustee of the ILIT. The insured/grantor cannot be a beneficiary of the ILIT without adverse estate tax consequences. Thus, the insured's spouse will be the primary beneficiary of the ILIT and, upon the spouse's death, the children will be the remainder beneficiaries. The trustee will be the initial owner and beneficiary of the policy. Finally, the ILIT will be designed as a "grantor" trust so that all items of income and deduction are taxed to (or deductible by) the grantor.
What are the tax consequences if the insured qualifies for LTCI benefits? First, the LTCI rider should not require the carrier to pay the benefits directly to the nursing home. If so, this will bring the trust assets back into the grantor's estate as a transfer with a retained interest (IRC Section 2036). As mentioned above, the grantor cannot benefit from the ILIT.
If the LTCI benefits are paid directly to the ILIT, the trustee can distribute such amounts to the spouse (or the children after the spouse's death) as beneficiary of the ILIT as needed for "health, education, maintenance and support." Thus, the grantor/insured can "indirectly" benefit from the LTCI benefits. But, the beneficiaries cannot be legally obligated to pay the grantor's LTCI expenses and there cannot be a "prearranged" agreement between the parties to do so without running afoul of IRC Section 2036. Finally, if the spouse or children pay the grantor's LTCI expenses directly to the care facility, such payments are not considered taxable gifts (IRC Section 2503(c)(2)(B)).
As a result of the Pension Protection Act of 2006 (PPA 2006), effective January 1, 2010, "tax qualified" LTCI riders will be treated, for tax purposes, as separate contracts. LTCI riders must clear these hurdles to be tax qualified:
- To receive benefits, the insured must be unable to perform at least two of these "activities of daily living" (ADLs): eating, bathing, dressing, getting out of bed, toileting and continence.
- A health care professional must certify that these conditions will last at least 90 days.
- Alternatively, the insured will be eligible for benefits if he/she requires supervision to protect himself/herself from threats to his/her health and safety due to severe cognitive impairment and this condition has been certified by a licensed health care professional within the previous 12 months.
If these conditions are met, tax-qualified LTCI riders offer two tax benefits: (1) the premiums may be deductible, and (2) the benefits will not be taxable. Generally, the premiums for a tax qualified LTCI rider are considered a medical expense and are deductible (for itemizers) to the extent they exceed 7.5 percent of the insured's adjusted gross income. But, the amount of the LTCI premium that is treated as a medical expense is limited by IRC Section 213(d), based on the insured's age. For example, in 2009, the limit is $1,150 for insureds between ages 50 and 60; $3,080 for insureds between the ages of 60 and 70; and $3,850 for insureds over age 70.
Benefits from reimbursement riders are not taxable, and benefits from indemnity riders are only taxable if they exceed the beneficiary's total qualified long term care expenses or $280 per day (for 2009), whichever is greater. Finally, PPA 2006 allows the LTCI rider to be funded through a partial cash surrender without taxation, so long as the investment in the life insurance policy is large enough to support the transaction. Thus, the LTCI rider can be acquired with pre-tax dollars, but then benefits from such riders so acquired will not be deductible.
In short, the appeal of using an LTCI rider is that someone will benefit from the combination policy. If LTCI benefits are not needed, the death benefit will pay out in full. In contrast, with a stand-alone policy, if LTCI benefits are not needed, the premiums are never recovered, but the extra coverage comes with an extra cost (i.e., the cost of the life insurance). Thus, if life insurance is not needed, a stand-alone LTCI policy should be used.
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