In 1996, the Health Insurance Portability and Accountability Act (HIPAA) provided that if a policy meets certain triggering events for payments of benefits, those benefits are received tax free. See IRC Section 7702B. HIPAA also spawned “combination contracts”, aka hybrid or asset-based LTC policies.
So, if Kim’s policy can be exchanged into a hybrid policy that will last without premium payments, the proverbial bus will result in a tax-free check for Tim just as it could after a modification or a traditional exchange. However, with the asset-based LTC policy, she also creates the possibility of drawing tax- free checks to cover her long-term care needs.
A similar possibility to get otherwise taxable income on a tax-free basis exists with annuity contracts. The Pension Protection Act of 2006 extended the tax-free treatment of life/LTC combo contracts to deferred annuity/LTC combinations. A client with a lot of growth in a deferred annuity provides a potential pool of tax free dollars for care by exchanging into an asset based annuity product.
Think about that. How often do you run into a client that is, say, already dealing with required minimum distributions and is reticent to take additional income taxed at ordinary rates from a deferred annuity?
If care is a concern, an asset-based LTC might have appeal. In fact, the underwriting is so different from life insurance or standalone LTC products, even some people for whom care is likely to be needed soon can get into a hybrid annuity.
Now, I would be remiss if I didn’t point out that I am omitting a lot of details. There are not a lot of products to choose from. I haven’t said anything about the ins and outs of 1035 exchanges or partial exchanges. Policies with loans complicate things and the tax treatment is not straight forward.
This column isn’t meant to be technical. I bring these hybrid products up simply because I don’t want financial planners who, like me, have been less than wowed by asset-based LTC products to dismiss them out of hand. In the right circumstances, these products can be useful.
Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla. You can reach him at www.moisandfitzgerald.com.