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mericanfor Long-TermssociationCare InsuranceGUIDE TOLONG-TERM CARE PLANNINGUSING 1035 EXCHANGESA TAX-ADVANTAGED WAY TO REPURPOSEEXISTING ANNUITIES & LIFE INSURANCE2018EDITION
WhoShould Read This Guide?INDIVIDUALS WHO HAVE AN ANNUITY OR ALIFE INSURANCE POLICYINDIVIDUALS WHO ARE INTERESTED INTAX-ADVANTAGED WAYS TO PLAN FORLONG-TERM CARE NEEDSMillions of Americans have annuities or life insurance policies.Yet few are familiar with Section 1035 of the Internal RevenueCode, which allows an individual to repurpose an existing annuitycontract or life insurance policy to include tax-advantaged LTCbenefits.This guide explains how 1035 exchanges work and how they maybenefit you. We believe you'll find the information of real value.Jesse Slome, Executive DirectorAmerican Association for Long-Term Care InsurancePlease noteWe believe plain-English information is what people want. This content is provided for overviewand informational purposes only and is not intended as tax, legal, fiduciary, or investment advice. 2018, American Association for Long-Term Care Insurance, all rights reserved.
Long-Term Care PlanningUsing 1035 ExchangesWhat's InsideThe BasicsThis section includes an overview of the PensionProtection Act (PPA). You’ll learn how a 1035exchange lets you convert an existing annuitycontract or life insurance policy to one that alsooffers tax-advantaged long-term care (LTC) benefits.41035 Exchanges and AnnuitiesMillions of Americans include annuities in theirretirement strategy. Discover the tax advantages ofqualifying annuities that offer LTC benefits, and seeexamples of 1035 exchanges of annuities.81035 Exchanges and Life InsuranceAmerican taxpayers are encouraged to purchase LTC protectionin ways that differ from traditional standalone, health-based LTCinsurance. For example, life insurance and LTC benefits can becombined in one policy. This section compares traditional lifeinsurance with policies that combine life and LTC benefits.14Share This Ebookwww.AALTCI.org/10353
The BasicsThe Section 1035 Exchangeprovides a powerful,tax-advantagedway to repurposean existing annuityor life insurance policy toone that also providesLTC benefits.DISCLAIMERIndividuals in scenarios included in this guide are fictitiousand numeric examples are hypothetical. Examples are usedfor explanatory purposes only based on real policies offeredby leading national insurance companies (as of December 2017).Numbers shown have been rounded.Share This Ebook4www.AALTCI.org/1035
Long-Term Care PlanningUsing 1035 ExchangesSection 1035 Exchange BasicsThe Pension Protection Act (PPA) allowsa 1035 exchange of an existing annuityor life insurance contract for a new onethat includes tax-advantaged LTCbenefits. The exchange must be madeaccording to specific Internal RevenueCode and IRS regulations.FREQUENTLYASKED QUESTIONSDoes my current company haveto let me exchange my contractor policy to another insurer?Yes. Companies are legally bound,though they may be slow torespond. Issues may arise when1035s are requested or processed.Be sure to work with an experiencedand knowledgeable professional toavoid delays and potential taxconsequences.The PPA was passed by Congress in 2006and became law in 2010. The actencourages individuals to buy LTCinsurance by providing tax advantagesto those who exchange existingannuities or life insurance forlinked-benefit annuity contracts or lifepolicies that also provide LTC benefits.What about IRAs and othertax-qualified funds?Section 1035 applies only tonon-qualified funds. But somestrategies allow rollovers (or directtransfers) to IRA annuities withtax-advantaged LTC benefits.The PPA allows individuals to plan forfuture needs and take advantage of taxincentives to purchase LTC protection.A solution is to convert a tax-deferredannuity contract or life insurance policyinto a tax-free asset to pay for qualifyingLTC costs.Contracts that may be exchanged under §1035Type of policy1 Life insuranceEndowmentAnnuityLTC Life NoYesYesLTCNoNoNoYes1to Contract must be "qualified" long-term care under IRC §7702B.This assumes payments begin no later than under the old contract.5
Benefits BeyondTraditional LTCCongress passedthe PPA to provideindividuals more tax-advantagedincentives to plan for LTC.Linked-benefit LTC solutionsare annuity contracts and life insurance policies that include thebenefits you’d expect, in addition to tax-free payments forqualifying LTC expenses.In 2016, more than three timesas many individuals purchased alinked-benefit LTC policy than traditionalhealth-based LTC insurance.161Source: American Association for Long-Term Care Insurance, 2016 sales data
Long-Term Care PlanningUsing 1035 ExchangesBenefits of Linked-BenefitLTC ProductsA primary advantage of a linked-benefitannuity contract or life insurance policy isthat the consumer receives benefits evenif he or she does not ever need LTCservices.These benefits could include: Premiums that never increase Benefits that never decrease Asset growth at guaranteed rates Access to funds if needed Death benefits if not used for LTC Return-of-premium options Lifetime LTC benefitsNote: Provisions for linked-benefit contracts or policies varybased on the type of product (life or annuity), the insurancecompany and even by state.Linked-benefit fixed or indexed annuitiescan provide LTC coverage. Before the PPA,annuity owners had to spend taxablegains before the principal could be usedfor tax-free purposes. Under the PPA, aqualifying annuity can pay for LTC costswithout tax consequences.FREQUENTLYASKED QUESTIONSAre linked-benefit LTC productssomething new?No. This concept and someproducts have been available formore than 25 years. The PPAprovides tax advantages andmakes 1035 exchanges a valuableLTC planning option.Do linked-benefit LTC productsprovide broad coverage?Yes. They can pay for home care,assisted living and adult day care,as well as nursing home care.Benefit triggers are the same astraditional LTC insurance. Toqualify, the individual must showthe inability to perform at leasttwo of six activities of daily livingor require care due to severecognitive impairment, such asAlzheimer's disease or dementia.Life insurance with LTC benefits canprovide a death benefit, LTC protection orboth. Under the PPA, a qualifying life LTC policy allows the policyholder to usethe death benefit as needed to pay forqualifying LTC costs. Any portion of thedeath benefit not used for LTC may bepassed to beneficiaries.7
Guide to 1035 ExchangesAnnuitiesMillions of Americansinclude fixed or indexedannuities in theirretirement strategy.A linked-benefit annuitycan help grow your assets,provide protectionfrom market downturns andhelp pay for qualifying LTC expenses.The PPA affords certaintax advantagesto qualifyinglinked-benefit annuities.8
Long-Term Care PlanningUsing 1035 ExchangesBenefits of Linked-BenefitLTC Products [Annuities]Many individuals allocate some "just incase" dollars into fixed or indexed annuitiesto help protect retirement income. In fact, in2016 the value of fixed and variable annuitiesexceeded 2.8 trillion.FREQUENTLYASKED QUESTIONSSource: U.S. Individual Annuity Yearbook, 2016 Data,LIMRA Secure Retirement Institute.People use annuities to provide retirementincome to last a lifetime, and for theknowledge that if funds are never needed(say for end-of-life care), they may pass to heirs.And if a person needs LTC? He or she can usefunds to pay for care, either by turning on theannuity income stream or making withdrawals.Both options may have tax implications.Annuities that meet PPA provisions letowners withdraw proceeds for LTC coverageand/or income. Annuity owners can pay forqualifying LTC costs income tax-free. Theflexibility and potential tax advantages aregood reasons to consider repurposing anexisting annuity.ExistingNonqualified AnnuityWhen is a 1035 exchange of anannuity a good idea?It’s a good idea when it affordsyou tax advantages; for example,when you can purchase tax-freeLTC benefits.Are partial exchanges allowed?Maybe. Partial exchanges may bepermitted with the gain, but theprocedures may vary byinsurance carrier.Does the PPA apply toqualified annuities?No. Qualified annuities under anindividual retirement account,such as Roth IRAs, SIMPLE, SEP or403(b) annuities, do not qualifyfor PPA tax advantages.Linked-Benefit Annuity(with gain cost basis)(payments for LTCexpenses only)PaymentsPaymentsGain(taxable)Section 1035ExchangeIncometax-freeCost basis(nontaxable)9
Individualsown annuitiesfor many reasons.Beyond the tax advantages and potentialaccount growth, annuities can help serve as anemergency fund in case of a catastrophic illnessor for in-home or nursing home care.THE SPECIALPPA ANNUITYTAX ADVANTAGEA PPA-qualified annuitycan serve these purposesand provide incometax-free withdrawals topay for qualifyingLTC expenses.Share This Ebook10www.AALTCI.org/1035
Long-Term Care PlanningUsing 1035 ExchangesComparing OptionsNonqualified AnnuitiesLet's look at a typical situation to compare the potential benefits ofrepurposing an existing nonqualified annuity at age 65.For example, a 65-year-old individual owns a nonqualified annuity obtainedat age 49. The cost basis is 75,000 with an average annual return of 2.5% for atraditional annuity and 1.5% for a linked-benefit annuity. Values are projected toage 85, when the likelihood of needing LTC is greatest.USING YOUR TRADITIONAL ANNUITYTO PAY FOR LTC EXPENSES COSTS BEFORE 180,000Available amount for LTC costs at age 85 180,000 (projected)Gain 105,000TaxableAccumulated value/cash surrender value (age 85) 180,000 (projected)Cost Basis 75,000NontaxableWithdrawals to pay for qualifying LTC care36 months @ 5,000/month (age 85) 105,000 SUBJECT TO INCOME TAXATIONUSING A 1035 EXCHANGE TO REPURPOSE INTO APPA QUALIFIED LINKED BENEFIT ANNUITYAnnuity is repurposed at age 65, and the 1035 Exchange amount is 110,000.AFTER 1035 500,000All withdrawalsto pay forqualifying LTCexpensesNontaxableAvailable amount for LTC costs at age 85 500,000 - payable over 60 months totalPayable at 4,400 for first 24 months, then,Payable at 12,000 for next 36 monthsValue at death if LTC is never needed 105,000ADVANTAGES OF LINKED-BENEFIT ANNUITIESGuaranteed, tax-deferred cash value growth. Tax-free LTC benefit payments.Assets that can be passed to beneficiaries.Optional lifetime protection.Benefits for owner and spouse.11
Who Should ConsiderLinked-Benefit Annuities?Individuals who:Are generally between ages 50 and 85.Have money set aside but have notfound an attractive LTC insurance product.Are not comfortableself-funding their LTC risk.Are turned off by the "use it or lose it" nature oftraditional health-based LTC insurance.Are generally in good health.Prefer an interest-based growth optionto protect their estate, limit risk andmaintain assets if they never need LTC.12
Comparing OptionsNonqualified AnnuitiesHow can one existing annuity be repurposed to secure lifetime LTC benefitsfor two spouses? Take a look.One spouse may own an annuity to pay for LTC. A downside is that a portion ofany withdrawals are taxable as income. Perhaps more important, if one or bothspouses need care for an extended time, the annuity value can be depleted, evenwhen LTC benefits are still needed.Some PPA-qualified annuities can provide access to "lifetime" or "unlimited" LTCbenefits. Benefits can cover LTC costs for one spouse or for both. Withdrawals forLTC are not subject to income tax. And if neither spouse needs long-term care,the beneficiaries receive the annuity’s full proceeds.USING YOUR TRADITIONAL ANNUITYTO PAY FOR LTC EXPENSESBEFORE 5,000 5,000 5,000 5,000 5,000Partially Taxable 200,000 currently available in a nonqualified annuityAnnuity owner, age 66 and spouse, age 62Withdrawals of 5,000/month to pay for LTC Roughly 40 months of withdrawalsWithdrawals are taxable to extent of gainUSING A 1035 EXCHANGE TO REPURPOSE INTO APPA QUALIFIED LINKED BENEFIT ANNUITYAFTER 1035 200,000 exchanged to a linked-benefit annuitySpouses, ages 66 and 62Withdrawals of 5,000/month to pay for LTC 5,000 Lifetime (unlimited) - payments, income tax-freeIncome Tax-FreeSuppose one spouse needs LTC for 24 months (2 years) and the otherfor 60 months (5 years). This linked-benefit annuity will payincome tax-free benefits of 420,000.If neither one needs LTC and the second spouse dies at age 94, thelinked-benefit annuity pays the designated beneficiaries 202,000.13
Guide to 1035 ExchangesLife InsuranceTime changes everything.The intended use of your life insurance policymay have changed. Maybe it'stime to exchange your coveragefor a product thatalso provides LTC benefits.The PPAallows for leverage andtax benefits for qualifyingLife LTC policies.One of consumers’ main concerns about LTCplanning is that they’ll pay premiums but maynever receive living benefits.Exchanging an existing lifepolicy can resolve this concern.14
Long-Term Care PlanningUsing 1035 ExchangesHow to RepurposeExisting Life InsuranceThe IRS lets you exchange an existing lifepolicy for a new one that includes LTC benefits(that is, a Life LTC policy) without paying taxeson realized gains.Consider these reasons for exchanging anexisting life insurance policy:Changing needs. As you grow older, thereasons you purchase life insurance maychange. You’ve probably thought about the riskthat you’ll need LTC one day, but you haven'tacted.An attractive LTC planning option.Consumers balk at the "use it or lose it" natureof traditional LTC policies. A Life LTC policywith a potential death benefit removes thisconcern. Plus, most offer guaranteed premiumswhich eliminates the risk of future premiumincreases.Better coverage and tax advantages. Olderpolicies likely don't include desired features,such as LTC benefits. The PPA lets you purchasethese benefits tax free.Stronger insurance company. If your policyhas a significant cash value, you may want totransition it to a carrier with better ratings andfinancial stability.FREQUENTLYASKED QUESTIONSHow do Life LTC policieswork?LTC riders generally areattached to a base lifeinsurance policy. If you needLTC, the base policy’s deathbenefit is used to pay forqualifying claims. After thedeath benefit is fully used, arider can extend LTC benefitsfor a specified time.Do these polices include anyguarantees for consumers?Yes. Policy guarantees includea death benefit if not used forLTC benefits and the option tohave your premiums returned.Premiums can be guaranteednot to increase, and assetsmay grow at a guaranteedrate.Do Life LTC policiesprovide broad coverage?Yes. Just like traditional LTCinsurance policies, thesepolicies pay for qualifyinghome care, assisted living orskilled nursing facility care.Share This Ebookwww.AALTCI.org/103515
Life LTC ProductAdvantages“Use It - Get It - Give It” ScenariosUse It - Live a long life and chances are you'll need LTC.With a Life LTC policy, you can typically access 100% ofdeath benefits for qualifying LTC expenses.Get It - You have the option to cancel a Life LTC policyand get some or all of your premiums back.Give It - Your Life LTC policy provides adeath benefit to your designated beneficiaries.THESPECIAL PPALIFE LTCADVANTAGEA PPA-qualified1035 exchange can servethese purposes andprovide income tax-freebenefits to payfor qualifyingLTC expenses.16
Long-Term Care PlanningUsing 1035 ExchangesComparing OptionsLeverage a Modest Life Policy forSignificant LTC BenefitsA 1035 exchange of even a modest life insurance policy can maintaina death benefit while adding tax-free LTC benefits.Example: A male, age 60, has a cash value life insurance policy worth 75,000.The death benefit is no longer important to him. His chief concern now is not toburden his family with potential LTC costs, which he worries could grow andconsume his nest egg.USING YOUR CASH VALUE LIFE INSURANCE POLICYBEFORETO PAY FOR LTC EXPENSESLife insurance can help fund LTC costs in several ways – with potential taxconsequences. And some policy values likely won’t grow at the same pace asrising LTC costs.USING A 1035 EXCHANGEAFTER 1035TO REPURPOSE INTO A LIFE LTC PRODUCTAge of LTC Claim(Lasting 22 months)Monthly LTC Benefit SurrenderLTC Potential Benefits ValueDeathValueStarts at age 70 3,600/month 52,000 83,000 63,000 83,000 71,000 83,000 121,000Starts at age 80 4,900/month 163,000Starts at age 90 6,200/month 205,000The benefits paid for LTC are not subject to income tax.The monthly LTC benefit grows at 5 percent (simple) annually.ADVANTAGES OF LIFE LTC POLICIESLTC benefit amounts may be guaranteed (e.g., benefits will never decrease).LTC benefits may be guaranteed for a lifetime, andpremiums can be guaranteed never to increase.Death benefits that are not used for LTC can pass to beneficiaries income tax-free.Policy benefits are always governed by the individual policy provisions which may vary.17
Why Life LTC ProductsAre Increasingly PopularFeatures, options and benefits may vary,but here are some reasonsLife LTC policies are increasingly attractive.Premiums guaranteed to never increase.Optional joint protection for spouse or other loved one.You can select unlimited (lifetime) LTC benefits.You can get coverage issued up to age 80, in most cases.Payments for qualifying LTC can be madefor the time period you choose.Inflation options help protect against rising LTC costs.You can get your premium backif you change your mind.You can take policy loans or pass the deathbenefit to heirs if it’s not used for LTC.18NOTE: Policy provisions vary from one insurance company and policy to another and may not be available in all states.Consult with a knowledgeable insurance professional experienced in selling life LTC policies.
Long-Term Care PlanningUsing 1035 ExchangesComparing OptionsTraditional Life Insurance versus Life LTC PolicyLet's look at another typical situation by comparing the potential benefits ofrepurposing an existing whole life insurance policy at age 66.Example: A female, age 66, has a cash value life insurance policy worth 150,000.She is retired and financially independent with grown children. She wants toleverage her policy’s tax-advantaged growth to maximize the available tax-freeLTC benefits.AFTER1035USING A 1035 EXCHANGETO REPURPOSE INTO A LIFE LTC PRODUCTAge of LTC ClaimMonthly LTC BenefitLTC Potential BenefitsDeath ValueStarts at age 76 6,800/mo. for first 25 mos. then 9,400/mo. for next 25 mos. 170,000 400,000 Potential BenefitsStarts at age 91 6,800/mo. for first 25 mos. then 14,700/mo. for next 25 mos. 170,000 535,000 Potential BenefitsThe guaranteed minimum interest rate is 4%.Benefits paid for LTC are not subject to income tax.The second 25 months of LTC coverage grows at 3%.Share This Ebookwww.AALTCI.org/103519
Long-Term Care PlanningUsing 1035 ExchangesWe Asked the1035-Exchange ExpertsWhat are the advantages of using a linked-benefitproduct to fund LTC expenses?Some individuals can't get past the "use it or lose it" natureof traditional LTC insurance. Linked-benefit products thatmeet PPA provisions generally allow tax-free withdrawals topay for qualified LTC expenses. Product riders typicallyprovide an LTC benefit pool from two to three times the basepremium amount.Are all linked-benefit products pretty much the same?No. There can be a significant difference in the potential LTCbenefit and/or the potential death benefit.Do I have to exchange the entire amount of my contractor policy to get the 1035 exchange benefits?Partial exchanges of annuities may be permitted, but thiswill depend on the individual insurance company. Partialexchanges of life insurance are generally not permitted.What types of annuities can be exchanged?Any nonqualified annuity may be used, subject to limitationsset by the transferring insurance company.Are annuity exchanges subject to a surrender penalty?To find the answer, work with a knowledgeable insuranceagent or financial professional who can help you evaluatethe new guaranteed rate, the added leverage and the taxadvantages of LTC benefits.20
Can I exchange my life insurance policy or annuitycontract by moving it from one company to another?Yes. Insurance companies are legally bound to honor asurrender request. Companies may be slow to process yourrequest, but they must honor it. Be sure to use the correct1035 exchange paperwork. Contracts or policies withirrevocable beneficiaries require sign-off before theexchange can be made.Can the policy or contract 'owner' be changed?The new policy/contract owner must be the same as theexisting owner. You can, however, change ownership beforeor after the exchange. Talk with an expert to avoid issueswith gifts, transfer value or gain recognition that could resultfrom any policy ownership change.Are linked-benefit products medically underwritten?Generally, the answer is yes. But the health qualificationsmay be less stringent than traditional health-based LTCinsurance. This is especially true for annuities.Is a 1035 exchange reported to the IRS?The insurance company typically requires a form with thesurrendered funds. This enables them to report thesurrendered amount as a nontaxable distribution on IRSForm 1099-R.21
Linked-Benefit AnnuityComparison WorksheetPolicy #1Insurance CompanyPolicy NameCompany Rating(A.M. Best)1035 Exchange AmountInitial LTC BenefitBalance (Total)Initial Monthly BenefitTotal LTC BenefitPeriod (Months)Continuation ofBenefits RiderPeriod (Months)Surrender Value5 Years10 Years20 YearsLTC WaitingPeriodBenefits Paid(Reimbursementor Cash/Indemnity)Special Features(e.g. Internationalfacility coverage)AdditionalAccess OptionsInflation Growth FactorMonthly Benefit @ Age 85MedicalUnderwriting /Medical ExamsSurrender Charges /Charges Waived22Policy #2Policy #3
Life LTCComparison WorksheetPolicy #1Policy #2Policy #3Insurance CompanyPolicy NameCompany Rating(A.M. Best)Guaranteed MinimumInterest RateInitial Life InsuranceDeath BenefitTotal LTC BenefitBalance AvailableTotal LTC BenefitPeriod (Months)LTC Benefit Amount(Monthly/Daily)Surrender Value5 Years10 Years20 YearsDeath Benefit5 Years10 Years20 YearsLTC Waiting PeriodBenefits Paid(Reimbursementor Cash/Indemnity)Special Features(e.g. Internationalfacility coverage)AdditionalAccess Options23
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American taxpayers are encouraged to purchase LTC protection in ways that differ from traditional standalone, health-based LTC insurance. For example, life insurance and LTC benefits can be combined in one policy. This section compares traditional life insurance with policies that combine life and LTC benefits. 1035 Exchanges and Life Insurance
insurance called Qualified Long-Term Care Insurance. This regulation is intended to provide requirements for all long-term care insurance contracts, including qualified long-term care insurance contracts, as defined in the NAIC Long-Term Care Insurance Model Act and by Section 7702B(b) of the Internal Revenue Code of 1986, as amended.
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Qualified long-term care insurance policies and qualified long-term care services are treated the same as health insurance for federal tax purposes. Both premiums for long-term care insurance and out-of-pocket expenses can be deducted from federal income taxes if the costs exceed the tax code's 7.5 percent base for medical expense deductions.
3.4. Interaction between public care and long-term care insurance 20 4. Health care system and insurance 21 4.1. Macroeconomic and other factors and overview 21 4.2. Health care that is publicly financed 22 4.3. Health insurance market 26 4.4. Interaction between public care and insurance market 32 References 33 Tables Table 1.
