By Babs W. Hart
President | Hart Insurance Group, Inc.
I like to say, "Friends don't let friends die with an annuity". Let me explain: an annuity is a good accumulation vehicle; the money grows tax deferred and there is an opportunity for guaranteed income. Unfortunately, a majority of those owning annuities die still owning them rather than exercising the options to have them pay out as a supplement to their retirement income. The heirs of that annuity will pay, not the lesser tax of capital gain, but the higher ordinary income tax. I had a lady come to me with an annuity that her husband had purchased 30 years ago. He had paid $50,000 and it had grown to $90,000 over that period. If she would have cashed it out (or left it to her son at her death), she would have paid taxes on the gain of $40,000. Because of the Pension Protection ACT of 2006, there was a solution for her; now you can move tax deferred assets into tax-free income to pay for chronic illness and extended health care, but we will get back to her situation shortly.
Even with Medicare, the greatest potential threat to your retirement planning is an extended health care need: few people have planned for spending $80,000 to $100,000 a year for services related to a chronic illness or other health issues common to old age. (This is in the south; the cost can be much greater in other parts of the country). To address this need for additional financial resources, the insurance industry introduced long-term health care insurance in the early 90s. All went well for about 20 years, until the companies offering the insurance realized that they had not properly priced their products to meet the demands at claim time and so began a series of rate increases. Meanwhile, other companies decided to discontinue even offering the product. This 'upheaval' sent many insurance carriers back to the drawing board; the problem was not going away, there needed to be a better solution. The solution has come in the form of 'linked products'. We now have combination products, life insurance and annuities with riders that allow the person access to 'living benefits'; meaning, you do not have to die to collect.
According to the Pension Protection Act, as of January 10, 2010, cash withdrawals from annuity contracts (that have this rider) pay out income tax free. To take advantage of this strategy your annuity has to be non-qualified assets and the annuity policy has to meet the HIPPA guidelines.
The lady I mentioned previously had moved her money over into an annuity that met the HIPPA requirements. Now in her 'linked' annuity product the entire cost basis plus the interest will be tax free when used for long-term care services. Additionally, her $90,000 annuity purchased over $250,000 in tax-free 'living' benefits for long-term care services. This is an excellent way to leverage money that is being saved for a 'rainy' day or what I call 'lazy' money. For example, a 67 year old could put $100,000 in a plan and have over $400,000 available for long-term health care services available in the first year and the entire distribution used for long-term health care services are tax-free.
The life insurance products that have 'linked benefits' allow the insured to access the death benefit (while still living) for a chronic illness or for long-term health care services. The benefits are paid out tax-free and whatever portion is not used for a health care need is paid to the beneficiary as a death benefit. This is a win/win proposition. The traditional long-term care policies that were introduced in the 90s meant paying premiums and possibly never seeing any of the benefits due to a sudden death, rather than a long illness. The ‘linked benefit’ life insurance product provides a solution.
It is possible to use the cash value in current life insurance policies to buy the new contracts that include a long-term care rider. You would need to be in good health, as the new contract will require completing a new application and a life insurance physical.
Babs W. Hart, President of Hart Insurance Group, specializes in Long-Term Health Care, providing essential information for evaluating the need for long-term health care protection. She is the author of the book Plan Ahead: Important Questions (and Answers) Regarding Long Term Care Insurance. She has earned a B.A. in Communications and Minors in Philosophy and Psychology from Auburn University; CLTC-Certification in Long-Term Care and is a member of the Million Dollar Roundtable (MDRT), Premier Association of Insurance Professionals. She works as an independent agent, researching the market place for the best contracts and rates from financially strong companies. She serves in an advisory capacity to CPA firms and estate planning attorneys. Ms. Hart has 20 years of experience working in the area of long-term care planning.
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The opinions expressed in this blog post are the author's own, and do not necessarily reflect the opinion of Red Oak Legal, PC.