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Combination Annuity and Long Term Care


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It’s common knowledge that our population is getting older and is quickly shifting from portfolio growth goals to guaranteed income and lifestyle type goals. There is an old saying that when a person is thirsty, they drink.  Regardless of current interest rates, people will always need guaranteed income streams that they can never outlive.

There are few things in life that let you do a do-over. Retirement is not one of them. Many people are still looking over their shoulder in fear of another market drop. Those market loss scars are permanent with most American’s, and the trade-off of contractual guarantees in lieu of upside opportunity seems to be winning over investors to the fixed-annuity story.

Saving for retirement is tough, but perhaps the biggest financial challenge comes once you stop working. After all, those years leading up to retirement leave you a certain margin for error — if your retirement savings start falling behind, you have options such as increasing your retirement savings rates over the next few years or even working a while longer than originally planned. Once you walk away from the workplace though, your savings are somewhat locked in — now you have to make them last.

It is a sobering thought as millions and millions of baby boomers are beginning their retirement. On top of that they are living longer than previous generations. It is only inevitable that the elderly will need more medical care than ever before. Yet, most will not have enough money to cover the costs that will accrue.

It is important for seniors to have a long-term care plan. Many folks dread and avoid discussing this planning. They know about seven out of 10 folks that reach age 65 will require some form of long-term care during their lives. They hope it is not them.

Some folks believe Medicare will take care of this problem. Unfortunately, Medicare only pays for medically-necessary care and only after the senior has spent at least three days in the hospital as an “admitted” patient. Even then, Medicare will only pay in full for the first 20 days of long-term care. The senior must pay a co-payment for the next 80 days. In 2013, that co-payment was $148 per day. After 100 days the Medicare coverage stops. Then the senior is responsible for all expenses.

It gets worse. Sometimes the hospital shows the senior as an “observation” patient instead of “admitted” patient. If the senior is considered an “observation” patient, Medicare will not pay anything for long-term care.

The common fear of wasting premiums on a traditional long-term care policy can be overcome with a combination/partnership “rider” on the life insurance or annuity policy.

As you can imagine, the federal government is worried about the burgeoning cost of long-term care and its impact on the federal budget.  Two major laws, the Deficit Reduction Act of 2006 (DRA) and the Pension Protection Act of 2006 (PPA), reflect Congress’ goals to discourage people to seek Medicaid benefits but also, to reward those who finance their own long-term care.  This is a classic “carrot and stick” story.

To discourage people from gifting assets in order to qualify for Medicaid sooner, the DRA changed the look-back period from 3 to 5 years.  Thus, all gifts made by a Medicaid applicant on or after February 8, 2006 are subject to a 5 year look-back period and will cause a period of ineligibility that only begins on the date of application.  As a result, those receiving the gifts will probably have to return the gifts before the Medicaid application is approved.  BEWARE!

One way to protect some of the assets you are growing now is to have a Qualified Long-Term Insurance policy in place. This policy can exempt your assets from being counted towards your Medical Assistance eligibility up to the value of the policy amount, as well as can provide you an opportunity to transfer assets out of your estate while getting  the care you need before needing to enroll for Medical Assistance benefits.

Congress wants to give incentives to people who buy long-term care insurance.  After all, it’s just too much of a drain on the federal government to pay everyone’s long-term care expenses.  The DRA and the PPA each contain important incentives.  FIRST:  the DRA authorized individual states, including Minnesota, to approve long-term care insurance “partnership” policies.  A person who collects benefits from a “partnership” policy can now qualify for Medicaid when that person reduces his or her available assets to the sum of $3.000 PLUS the amount of benefits collected from the policy.  This is BIG!

The PPA contains an important tax provision that took effect January 1, 2010.  This new tax provision allows a person who owns a non-qualified annuity to make a tax-free exchange of the annuity for (1) an approved long-term care insurance policy or (2) a new “combination” annuity which is a fixed with a long-term care rider.  Again, an example will illustrate the importance to you of this new law.

Assume Helen, age 70, owns a fixed non-qualified annuity which lists her children as beneficiaries.  Helen originally paid $20,000 for the annuity, and it’s now worth $70,000.  If Helen cashes in or takes withdrawals from the annuity, the first $50,000 of withdrawals will be taxed as ordinary income.  However, in light of the PPA, Helen can now make a tax-free exchange of the old annuity for a new COMBINATION annuity.

One type of combination annuity would provide Helen with long-term care benefits equal to THREE TIMES the value of the annuity, or $210,000, TAX-FREE!  (However, Helen must wait two years after the tax-free exchange before she can access the long-term care benefit.)  If Helen needs care after two years, the $210,000 of tax-free benefits will be paid out to Helen in the form of a daily benefit of $96 per day for up to six years.  Helen will use this daily benefit, along with her social security and other fixed income, to pay for her long-term expenses.

EVEN BETTER:  If Helen never needs long-term care, upon her death her children will still get to inherit the FULL VALUE of the annuity.  If Helen uses some portion of the annuity for long-term care, Helen’s children will inherit an amount equal to the value of the annuity less the amount of long-term care benefits paid to Helen.  Thus, if Helen received long-term care benefits of $30,000, her children would still inherit $40,000 ($70,000-$30,000), all of which will be taxable income to the children.

Note:  that this tax-free exchange can only be made from a “non-qualified” annuity.  Qualified annuities (those that are held in an IRA, 401(k), 403(b), etc) do not qualify for this special tax treatment.

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Wednesday, March 12th, 2014 Wealth Preservation

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