Tax advantages of long-term care insurance
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Long-term care insurance is a tough sell these days because many Americans find it difficult to commit to years of premium payments toward an uncertain future for something they may never need.
However, the looming tidal wave of 70 million retiring baby boomers has prompted federal and state governments to sweeten the long-term care deal by offering tax incentives to those who purchase long-term care insurance, hoping to lessen the potential drain on Medicaid resources.
The recent decision by Health and Human Services to shelve the Community Living Assistance Services and Supports, or CLASS Act, portion of health care reform ironically may help insurers get the word out about the tax advantages of owning a long-term care policy.
“Most people are not aware of the tax deductibility of long-term care insurance,” says Jesse Slome, executive director of the American Association for Long-Term Care Insurance. “People who have been waiting for the CLASS Act to come riding to the rescue, well, that’s not going to happen right now. But there is good news: Long-term care premiums are tax deductible, and the limits went up again this year. That is good news.”
If you’ve been on the fence about long-term care insurance, here are six long-term care insurance tax breaks that may affect your decision.
For individuals, the Internal Revenue Service considers tax-qualified long-term care premiums a medical expense. To what degree that will save you money on your taxes largely depends on your age and how you make a living.
If you work for someone else and itemize your deductions, you can deduct your long-term care premiums under medical expenses on Schedule A. However, because the long-term care insurance portion is capped by age and because only the portion of your total medical expenses that exceeds 7.5 percent of your adjusted gross income is deductible, few employed individuals realize a full deduction on their long-term care premium.
“It’s not really a great deduction because you would have to have a whole bunch of medical expenses before you can even get to the long-term care premium being deductible,” says Scott A. Olson, a long-term care insurance agent based in Redlands, Calif.
However, Slome points out that since the long-term care cap increases with age (at 40, the 2012 limit is $350; at 60, it’s $3,500), as health problems arise later in life, the long-term care deduction becomes more meaningful.
“As your medical expenses increase, when you add your LTC insurance into it, that could put you over the 7.5 percent,” he says. “It may not happen when you’re young, but down the road where you’re more likely to have other medical expenses, it may all become deductible.”
The tax advantages of a long-term care policy ramp up sharply if you’re self-employed. Rather than listing your premiums on Schedule A, they go directly on line 29 (“Self-employed health insurance deduction”) on Form 1040.
“It’s a great deduction because it comes off the top of your income,” says Olson. “That could mean $900 to $1,000 a year in reduced taxes if you’re in a 28 percent tax bracket.”
James Sullivan, a CPA and personal financial specialist based in Naperville, Ill., says the self-employed can reduce their taxable income substantially. “In addition, you can include eligible premiums paid for your spouse and dependents,” he says.
An extra incentive for part-timers and work-from-home parents: You don’t have to be self-employed full time to enjoy the deduction, Olson says.
C corporation deduction
If you own or belong to a C corporation, the tax savings alone can be a compelling reason to purchase long-term care insurance.
“A C corporation gives you the greatest tax deduction,” says Slome. “They have the greatest latitude in terms of what they’re able to do. You can deduct 100 percent of the LTC premiums, they’re not subject to the age-based limits and the business can establish a defined group that the business pays for.”
For instance, a C corporation may set up a defined group consisting of upper management and purchase long-term care policies for each member and their spouses. To really maximize the tax savings, they may even opt for accelerated payment of the policies, typically over a 10-year period or to age 65, according to Slome.
“So now you’ve accelerated the tax deduction when the company needs it, and at age 65 when you stop working or own the company, you now own LTC insurance that is fully paid for,” says Slome. “You never have to pay a penny in retirement, and you never have to face rate increases because it’s paid for.”
Cash-value life insurance and nonqualified annuities
Uncle Sam has also created a tax incentive for owners of cash-value life insurance and nonqualified annuities to shift some of their money into long-term care insurance.
Interest withdrawn from a cash-value life or annuity is normally taxed, says Olson. But if you use that interest to pay your long-term care insurance premium, you avoid the taxman completely.
“If you have substantial cash buildup in a nonqualified annuity, you can even do a tax-free exchange into an annuity that has an LTC rider,” says Sullivan. “If you need it for long-term care, the payment is going to come out as a nontaxable benefit, and in the meantime, the internal cash buildup within the policy can be used to pay the premiums tax-free.”
In the same way, owners of old cash-value life policies can do a tax-free transfer into a single-pay long-term care policy without having to pay tax on the gains within the life policy.
State income tax credits
Half of the states offer some form of tax credit or state income tax deduction as an incentive to purchase long-term care insurance, with some ranging as high as 25 percent of the total long-term care insurance premiums paid during the taxable year.
“Nobody knows about that, including many accountants,” says Slome. “Not only are there tax deductions in a few states, there are tax credits, which are even better.”
HSA/MSA premium payments
If you have a health savings account or Medicare medical savings account, you can use the money in your account to pay for most or all of your long-term care insurance premiums on a pretax basis.
“If you maximize your HSA every year while you’re employed, when you retire, you can have enough in the HSA to pay for your LTC premium each year,” says Olson.