Upheaval in the long-term care (LTC) market has drastically increased premiums and reduced consumer choice. In the last couple years, many LTC carriers left the market or dramatically increased their rates when they discovered that they had dramatically underpriced coverage.

MetLife, for instance, eliminated its long-term care insurance products at the end of 2010, saying that interest rates, among other things, made the product line impossible to continue. At the same time, John Hancock announced that it was raising premiums on in-force policies by 40%.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of long-term care insurance in Advisor’s Journal, see Long-term Care Insurance Reform Act of 2010 (CC 10-46) & Long-Term Care Insurance—A Desirable, Tax-Advantaged Employee Benefit (CC 08-28).

For in-depth analysis of long-term care insurance, see Tax Facts: Long-Term Care Insurance.

Your questions and comments are always welcome. Please post them below or call the Panel of Experts.

Why is this Topic Important to Wealth Managers? This blogticle provides discussion and analysis on the tax treatment of certain annuities. The blogticle provides detailed information for those wealth managers who sell annuities and for those who have clients with or are considering annuities.

In general, earnings and gains on a deferred annuity contract are not subject to tax during the deferral period in the hands of the holder of the contract.[1] When payout commences under a deferred annuity contract, the tax treatment of amounts distributed depends on whether the amount is received as an annuity (generally, as periodic payments under contract terms) or not.

For amounts received as an annuity by an individual, an exclusion ratio is provided for determining the taxable portion of each payment.[2] The portion of each payment that is attributable to recovery of the taxpayer’s investment in the contract is not taxed. The exclusion ratio is determined as of the taxpayer’s annuity starting date. Once the taxpayer has recovered his or her investment in the contract, all further payments are included as ordinary income. If the taxpayer dies before the full investment in the contract is recovered, a deduction is allowed on the final return for the remaining investment in the contract. Generally speaking, section 72 uses the term ‘‘investment in the contract’’ in lieu of the more commonly applicable term ‘‘basis.’’ Amounts not received as an annuity generally are included as ordinary income if received on or after the annuity starting date, and are included in income to the extent allocable to income on the contract if received before the annuity starting date (i.e., as income first).[3]

Moreover, present law provides for the exchange of certain insurance contracts without recognition of gain or loss.[4] No gain or loss is recognized on the exchange of: (1) a life insurance contract for another life insurance contract or for an endowment or annuity contract or for a qualified long-term care insurance contract; or (2) an endowment contract for another endowment contract (that provides for regular payments beginning no later than under the exchanged contract) or for an annuity contract or for a qualified long-term care insurance contract; (3) an annuity contract for an annuity contract or for a qualified long-term care insurance contract; or (4) a qualified long-term care insurance contract for a qualified long-term care insurance contract. The basis of the contract received in the exchange generally is the same as the basis of the contract exchanged.[5]

In interpreting section 1035, case law holds that an exchange of a portion of an annuity contract for another annuity contract qualifies as a tax-free exchange.[6] Treasury guidance provides rules for determining whether a direct transfer of a portion of the cash surrender value of an annuity contract for a second annuity contract qualifies as a section 1035 tax-free exchange. Under the Treasury guidance, either the annuity contract received, or the contract partially exchanged, in the tax-free exchange may be annuitized without jeopardizing the tax-free exchange (or amounts withdrawn from it or received in surrender of it) after the period ending 12 months from the receipt of the premium in the exchange.[7]

Section 2113 of the Small Business Jobs Act of 2010 [8] permits a portion of an annuity, endowment, or life insurance contract to be annuitized while the balance is not annuitized, provided that the annuitization period is for 10 years or more, or is for the lives of one or more individuals.

The provision provides that if any amount is received as an annuity for a period of 10 years or more, or for the lives of one or more individuals, under any portion of an annuity, endowment, or life insurance contract, then that portion of the contract is treated as a separate contract for purposes of section 72.

The investment in the contract is allocated on a pro rata basis between each portion of the contract from which amounts are received as an annuity and the portion of the contract from which amounts are not received as an annuity. This allocation is made for purposes of applying the rules relating to the exclusion ratio, the determination of the investment in the contract, the expected return, the annuity starting date, and amounts not received as an annuity.[9] Generally, a separate annuity starting date is determined with respect to each portion of the contract from which amounts are received as an annuity.

Tomorrow’s blogticle will continue our series on tax law changes related to wealth managers in 2011.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] IRC Sec. 72.

[2] RC Sec. 72(b).

[3] IRC Sec. 72(e).

[4] IRC Sec. 1035.

[5] RC Sec. 1031(d).

[6] Conway v. Comm’r, 111 T.C. 350 (1998), acq., 1999–2 C.B. xvi.

[7] See generally, Rev. Proc. 2008–24, 2008–13 I.R.B. 684.

[8] Public Law 111–240.

[9] Secs. 72(b), (c), and (e).

NB: All or parts of this work may have originally appeared under government publication intended for the general public.

Why is this Topic Important to Wealth Managers? The decision to buy long term care insurance is an important on for most clients. We have thus presented information relating to the sale and purchase of long term care insurance contracts.

Long term care can mean many different things, but any chronic or disabling condition that requires nursing care or constant supervision can bring on the need for long term care services. Long term care means not only care in a nursing home, it can also mean nursing care in a patient’s home and help with the activities of daily living, such as dressing, eating, bathing and taking medicine.

There are many different services that would fall under the definition of long term care. These services include institutional care, i.e., nursing facilities, or non-institutional care such as home health care, personal care, adult day care, long term home health care, respite care and hospice care.

Long term care is very expensive, and most people cannot afford to privately pay for long term care services for very long. For example, nursing home costs are approximately $376 per day in Long Island, New York or $137,240 per year. It is estimated that persons in nursing homes stay for 2½ years on average. [1]

Home health care is also expensive. The average cost of home health care in New York State in 2010 was approximately $20 an hour. Assuming 20 hours of care per week, this represents average home health care costs in New York of over $20,000 per year. Furthermore, the chance of needing some type of long term care services is fairly high. It is estimated that over 40% of all persons who were 65 years old in 1990 will enter a nursing home during their lifetimes.

Moreover, Medicare does not pay for most long term care services. Therefore, individuals should generally not rely on Medicare to meet their long term care service needs. Medicare does not pay for custodial care when that is the only kind of care needed; and skilled nursing facility care is covered by Medicare but only on a very limited basis.

Insurance as an alternative

Since the cost of long term care will not be covered by the Federal Government, insurance policies are one way that individuals can protect themselves. Most insurance policies covering long term care services currently being sold are indemnity policies. Indemnity policies are those that pay a specific dollar amount for each day an individual spends in a nursing facility or for each home health or home care visit.  Some of these policies pay the daily benefit amount regardless of the charges; others will pay covered charges, or a percentage of covered charges up to the daily benefit amount.

Over time, as nursing home and home care charges increase, the daily dollar amounts which are payable under these policies do not increase, however, insurers selling these policies are usually also required at the time of sale to also offer an “inflation protection” benefit. This benefit increases the daily benefit amount over time to help keep pace with inflation and increased expenses. Without the “inflation protection” benefit, an individual will be paying a larger amount of money out-of-pocket should one need to avail oneself of nursing home care or home care.

Some insurers also offer an option to increase the daily benefit amounts and maximum policy benefit at a future time. Under this option, an individual has the ability to increase the amounts every specified number of years. Unlike an inflation protection benefit purchased at the same time as the policy, if an individual opts to increase the daily benefit amounts and maximum policy benefit under this option, the premiums will increase based on the individual’s attained age at the time he or she opts to increase the benefit.

Tomorrow’s blogticle will continue to discuss wealth management planning techniques.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] For insurance statistics in this article see generally, New York State Insurance Department. A Consumer Guide to Long Term Care Insurance in New York. December 2010. http://www.ins.state.ny.us/ltc/ltc_guide.pdf. Last Accessed 4/4/2011.

If enacted, Congressman Lloyd Doggett’s proposed H.R. 5890, the Long-term Care Insurance Reform Act of 2010 (Long-Term Care Act), would have a drastic impact on insurers and producers who sell long-term care insurance.

Today’s analysis by our Experts Robert Bloink and William Byrnes is located at AdvisorFX Journal Long-term Care Insurance Reform Act of 2010

After reading the analysis, we invite your questions and comments about indexed annuities by posting them below, or by calling the Panel of Experts.