Fixed Annuities

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

While annuities have been utilized for many years as a funding source to pay Long Term Care (LTC) Insurance premiums, the Pension Protection Act of 2006 opened the door for non-qualified annuities to pay these premiums tax-free beginning 1/1/2010. Annuities issued thereafter have emerged combining Annuity and LTC benefits into a single "Hybrid" contract.

1035 exchanges under the Pension Protection Act

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 LTC Insurance premiums via what is known as a Section 1035 exchange. For background, a 1035 exchange is the replacement, or exchange, of an annuity or life insurance policy without adverse 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 to a new life insurance policy.)

The Pension Protection Act now permits 1035 tax-free exchanges to fund LTC Insurance policy premiums. In a 1035 exchange from a non-qualified annuity to an LTC Insurance policy, the gain in the annuity contract is 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.

Annuity/LTC Hybrid Policies

Annuity/LTC Hybrid policies are insurance contracts that have only minimal health underwriting and provide leveraged benefits payable up to two or three times the contract's value when the insured uses LTC services according to the terms of the policy. Couples can purchase Hybrid products on a joint basis.

Beginning 1/1/2010, any consumer holding a non-qualified annuity can move funds tax-free to an Annuity/LTC Hybrid policy via a 1035 exchange. The rules specify that a Tax Qualified LTC Insurance (QLTCI) rider under a non-qualified annuity contract will be treated as a separate contract, thus QLTCI benefits paid from these riders are fully tax free. Further, LTC rider cost of insurance charges against the contract value are not a taxable distribution (although they will reduce the annuity's cost basis).

Annuity/LTC Hybrid policies typically appeal to consumers who understand the LTC risk but have opted to self-insure due to the use-it-or-lose-it nature of traditional LTC Insurance policies. With Hybrids, the leveraged account value can be directed tax-free for LTC services should the need arise. Since the annuity's contract value itself will be drawn down for LTC expenses, insurance cost is reduced; and, if LTC services are never needed, the annuity's accumulated value passes to beneficiaries upon death.

Further information on Fixed Annuities may be found by clicking on the links below. If you would like a consultation or a product illustration, please Contact Us or Request a Custom Quote.

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• Who Should Buy an Annuity?
• Options for Taking Annuity Payments (Annuitization)
• Annuity Charges and Fees
• Buying a Deferred Annuity for Accumulation or Guaranteed Income
• How Fixed Annuities Can Be Used to Cover the Long Term Care Risk