1035 Exchanges To Purchase Long Term Care Insurance Protection With Significant Tax Advantages
The Pension Protection Act of 2006 that actually took effect beginning in 2010 enables individuals to take advantage of a new means for tax-favored long term care insurance payments.
While the Association does not offer tax or legal advice and strongly advises that all individuals consult with their accountant or tax professional, the following provides information shared by leading experts in the field.
Because NOT all long term care insurance companies accept 1035 exchanges and because insurance policies can vary significantly from one insurance company to another, we strongly suggest you call the Association to connect with a designated specialist who can answer your questions without cost or obligation. Call our offices at (818) 597-3227.
1035 Exchanges From Life or Annuities: The process involves completing a 1035 exchange from an existing life insurance or annuity policy into a long-term care insurance policy that permits 1035 exchanges. It should be noted at the onset that not all insurers will accept a 1035 exchange.
Benefits of a 1035 Exchange: A 1035 exchange defers the internal build up of gains associated with the life insurance or annuity policy. Because of the tax-free nature of long term care insurance, the 1035 exchange effectively ensures that the taxable gain disappears entirely.
As a result, individuals with an existing life insurance or annuity policy with a gain may wish to complete a 1035 exchange. Actually, a partial 1035 exchange is more common. This involves using the 1035 exchange to pay the annual long term care insurance premium and, as a result, gaining a more preferable tax treatment for funding their LTC coverage.
The Pension Protection Act of 2006 altered the Section 1035 rules to allow traditional annuity and insurance policies to be exchanged on a tax-deferred basis for the newly approved long term care hybrid (life insurance or annuity) policies.
In addition, the Pension Protection Act authorized another new form of 1035 exchange. This permits exchanges from a life insurance or annuity policy to a standalone, traditional long term care insurance policy.
Under the new rules of Internal Revenue Code Section 1035(a) (as established by Section 844(b) of the Pension Protection Act), individuals can complete a "like-kind" exchange from an insurance or annuity policy directly to a qualified long-term care insurance policy. The new law stipulates that the long term care insurance policy must be a "tax qualified" policy as defined under IRC Section 7702B. Today, the vast majority of policies meet these criteria. The rules also stipulate that the annuity policy must be non-qualified annuity. These are generally defined as annuities purchased with after-tax funds (as opposed to IRAs or retirement annuities that are purchased with pre-tax dollars).
In order to receive the tax-deferred treatment on the exchange, all the standard requirements of the 1035 exchange must be honored. The most significant requirement stipulates that the amounts must be assigned directly from the old life insurance or annuity policy directly to the new long term care insurance company issuing the policy. If the funds are distributed to the policy owner, they are deemed by the IRS as irrevocably distributed and the normal taxation rules apply.
IMPORTANT REQUIREMENT; To obtain the favorable tax treatment of a 1035 exchange, the company issuing the new long term care insurance policy must be willing and able to obtain the funds directly from the prior life insurance or annuity company in accordance with the rules of a proper 1035 exchange. At the present time (summer 2012) we know of two companies that are accepting 1035 exchanges (Genworth and MedAmerica).
Why Consider A 1035 Exchange ?
The primary benefit for those with an existing life insurance policy that may either have significant cash build up or is no longer needed -- or for those with a non-qualified annuity that has enjoyed significant tax-free build-up -- is the option of a new mechanism for paying for long-term care insurance.
The gain in your life or annuity disappears entirely (no tax consequences). This is significantly favorable tax treatment. In addition, remember that the rules for tax qualified long-term care insurance stipulate that benefits are received tax-free, and there is no formal cash value from an LTC policy that could otherwise be taxable.
Partial 1035 Exchanges Into Long-Term Care Insurance
Because long term care insurance companies no longer offer single-premium policies (where only one payment was required) most individuals today make systematic partial 1035 exchanges from an existing life insurance or annuity policy.
However, feedback provided to the Association has indicated not all insurers are really set to accomplish this. A reason we stress working with a knowledgeable long term care insurance professional who can be your advocate with the respective insurance company Home offices,
To meet the IRS requirements, the insurance company must comply with the 1035 exchange in order for the preferential tax treatment to apply. If the insurance company is not prepared and/or does not know how to process the 1035 exchange properly, it is not available as a payment mechanism.
As partial 1035 exchanges become more popular, it is very likely that more long term care insurance companies will implement the necessary policies, procedures, and requisite paperwork necessary to accommodate the transaction.
Get A No-Obligation Long Term Care Insurance Costs
We recommend reading free guides that provide excellent information and advice on reducing long term care insurance costs. Simply click the link. There is NO sign-in information required to read the guides which were originally published by the Association in Kiplinger's Personal Finance magazine issues.
Let a designated long-term care insurance professional show you how a 1035 exchange can benefit you and compare costs from leading insurers. Click here to complete our simple online questionnaire.