Marc Glickman

Reprinted from the CLTC Digest in cooperation with Certification for Long-Term Care, LLC, www.ltc-cltc.com. Email Amber Pate at [email protected] for a more than 20% discount on CLTC training for Broker World subscribers—just mention code BWMAG.

Which is the best type of business line for long term care planning—health, life, or annuity-based LTCI? How can I compare different LTCI plans to determine which is right for my clients?

       —Overwhelmed in Oregon

My most important client just received a long term care insurance rate increase. What should he do with his existing policy and should I consider a new carrier for his LTCI coverage?  —Fearful in Florida

Dear Fearful,

First of all, let me empathize with your client. Nobody wants to receive a rate increase letter. Now that you have the details in front of you, you have a chance to be a hero for your client. The best solution is probably to doing nothing more than reinforce the value of the original plan.

Most LTCI rate increases were a result of the original coverage being underpriced. It is likely that more claims will be paid out than originally anticipated. It turns out few people lapsed their policies each year and more people will eventually claim benefits. At the same time, the insurance carrier investment portfolios are earning much less than originally expected because of today’s low interest rates. This means that the carrier needs to request extra premiums to fund the extra cost of future claims. Analogously, it is even more difficult to self-insure an extended care event as an alternative to dealing with the rate increase when low risk investments are earning low rates of return.

One positive of the current lapse and interest rate expectations is that new products being sold today  are much more likely to be price stable. A recent Society of Actuaries study1 estimates that, even under adverse circumstances, today’s products have less than a 10 percent chance of needing a future rate increase. So, despite higher prices, new LTCI products still provide significant protection against a catastrophic long term care need and with more price stability. Traditional LTCI remains the least expensive way to fund an LTCI plan.

Carriers that are filing for rate increases on their legacy products are trying to improve the adequacy of premiums to be more in line with today’s new products. However, the price after the rate increase is usually still lower than today’s price for the same benefits! This is despite the fact that the lower original prices have been paid for many years. This demonstrates that the insured has typically received an extremely good value on their existing coverage as long as the increased premium is at a level they can still afford to pay.

Inside the Numbers
This leads us to a method of analyzing the value of your client’s original plan by using new product pricing. It is very likely that the reasons for the client’s original purchase of LTCI protection are even more relevant today now that they are older. We are going to use the price of today’s new policies to assess whether the client is best served maintaining their current plan. This will, at the same time, highlight the value of the original plan even after considering rate increases.

Let’s go through the analysis with a sample client that purchased LTCI 10 years ago when she was 55 years old. Let’s assume she paid a premium of $2,000. Now at age 65, she has paid $20,000 into the plan. The client received a 50 percent rate increase, bringing her annual premium up to $3,000. She is planning for her long term care needs in another 20 years at age 85.

Run two new quotes from a current LTCI carrier’s product. Both quotes should match the original benefits. If you are recommending a client reduce benefits, you can also compare new quotes at that reduced benefit level. Run the first quote using the client’s original issue age and the second quote using the client’s current age. You will use the first quote as the hypothetical cost of a plan reflecting current actuarial assumptions. You will use the second quote to represent the replacement cost of a plan should the client have any thoughts of forgoing their current coverage.

LTCI premiums are around 2.5 times more expensive for the same benefits compared to plans sold 10 years ago.2 The increase will be less noticeable for males compared to females because of the industry shift to gender specific rates. Yet, the average LTCI premium purchased today of about $2,500 is almost the same average price as 10 years ago after adjusting for inflation.3 The reason for this seeming anomaly is that lower benefit periods and/or lower inflation rates are purchased on plans today. Lifetime benefits and five percent compound inflation used to be the most commonly purchased plan. Three or five year benefit periods and three percent compound inflation are more commonly purchased today. Reducing benefits instead of paying a rate increase results in the client having benefit structures that are more in line with today’s policies.

The cost for our sample client’s coverage today at her original age and rate class would be closer to $5,000 today instead of the $2,000 she originally paid. At this point it should be clear that the $3,000 it will cost her to continue her current plan is still a great value compared to the $5,000 that she would spend buying a new policy today with the same benefits.

Use the first quote you ran to evaluate your client’s actual situation. Each situation will be unique based on gender, product, state, and carrier.

Now let’s assess the client’s current alternatives:

Scenario A – Client decides to lapse her current coverage.
The $20,000 already paid into the plan is a sunk cost. She is likely to be eligible to receive a very limited benefit (contingent nonforfeiture) should she lapse the policy.

If a new policy is 2.5 times more expensive at the client’s original age, it will almost certainly be even more expensive now that the client is 10 years older. If the client originally purchased five percent compound inflation protection, also keep in mind that she has already accrued significantly higher benefits during the first 10 years of owning the policy. Also, it is possible that the client may no longer qualify at the same preferred health class or may not qualify at all because of a change in health during the 10 year period.

You might think it makes sense to replace her coverage with another type of plan like a combo policy that combines a life or annuity product with a long term care rider. This might be attractive if the client’s needs or preferences have changed. However, it will be very difficult to replace the value paid into the original policy, especially considering that the life or annuity plan is typically much more expensive than the traditional LTCI plan for the same level of LTCI protection.

Scenario B – Client decides to keep her current coverage.
She has another estimated $60,000 ($3,000 x 20) remaining to fund the plan assuming no additional future rate increases. The value of the existing coverage will continue to increase as she pays premiums, even if she prepares for the possibility of needing to fund an additional future rate increase.

Scenario C – Client decides to reduce policy benefits.
Most LTCI rate increases provide for a “landing spot” approach that allows the policyholder to reduce benefits while keeping the premium close to the original level. This way, the client may be able to both lock in the value already paid, still retain significant benefits, and keep the premiums at an affordable level.

Out of the three scenarios, real world data suggests that most clients keep their current coverage. Individual situations differ based primarily on the magnitude of the rate increase(s). This author estimates that roughly 70 percent of people pay the full increase premium, 25 percent reduce their benefits, and only five percent lapse their policies.4  After paying the rate increase, those policyholders tend to be even less likely to lapse their policies in the future. This indicates that most clients are making rational decisions and most long term care advisors are giving solid advice.

The main ongoing question is: Will there be additional rate increases? There is now significant rate increase data to assess this risk. The California Department of Insurance5 publishes data for rate increases across all states. The majority of rate increases have occurred on policies issued prior to the adoption of rate stability regulations in the early to mid 2000s. In the California report, you can review both the rate increase amount approved, and also the amount that was originally requested by the company. It is more likely that another rate increase will be requested if the full amount of the original filing was not granted. Be aware that this is not an exact science because company experience continues to develop and actuaries can refine pricing assumptions and models.

Some advisors also question the viability of the existing carriers. However, there is a robust regulatory framework that reviews every carrier’s ability to pay claims and takes action accordingly.

In Conclusion
Insurance by its nature will always have those that are fortunate enough to receive little or no benefits, while others will receive large amounts of benefits due to the misfortune of requiring care. Yet, this is the primary reason for buying LTCI coverage. The insurance funds help ease the financial and emotional burden that comes with a need for extended care. Those that have received rate increases and have not yet received benefits should not feel as if their money went to waste. Just like term life, health, auto, or homeowners, the insurance provides peace of mind. They are still better off being healthy and not having a need for long term care. In fact, these policyholders had great foresight to lock in the once-in-a-lifetime value offered by low premiums and the wide availability of richer benefits. You see this phenomenon clearly when someone who purchased 10-pay receives a rate increase on their last remaining premiums. Their phone call to the advisor is usually one of gratitude.

It is hard to take the emotion out of receiving an unanticipated rate increase. Luckily, they have their trusted advisor to count on to help them keep their best options on the table. Usually, this is the plan they already have in place. Add value by asking them if they own a profitable business. They may not have considered that the rate increase could be an additional business expense deduction. In fact, they may not yet be deducting the premium at all! See the April, 2018, Dear Actuary Broker World article for more details. After your conversation it is even possible that they will look to add more LTCI coverage to supplement their existing plan. Taking that initial phone call from the client may make you feel like the goat, prove instead in their eyes to be the G.O.A.T. (Greatest of All Time). You will be surprised how addressing their fears the right way will open many doors to getting clients coverage in the future. 

Footnotes

1. https://www.soa.org/Files/Sections/ltc-pricing-project.pdf.
   
2. Based on Broker World Survey data.
   
3. Based on LIMRA Survey data.
   
4. Based on major carriers that have reported these statistics in public statements.
   
5. For Inactive Companies: https://www.insurance.ca.gov/01-consumers/105-type/95-guides/05-health/01-ltc/rate-history-inactive.cfm.
   For Actively writing carriers: http://www.insurance.ca.gov/01-consumers/105-type/95-guides/05-health/01-ltc/rate-history-active.cfm

   Every situation is unique, so always have your client consult their long term care, legal, or tax advisor. The views discussed in this article are opinions of the author, and not National Guardian Life (NGL), LifeCare Assurance, or CLTC.

What is the impact of the recently passed Tax Reform on federal long term care insurance deductibility for business owners?  —Taxed in Texas

Dear Taxed,

The Tax Cuts and Jobs Act (“Tax Reform”) was signed into law in late 2017. It is complex and still being analyzed by tax experts and advisors. In this article, we will explore the possible impact of changes to the tax code and how those changes might affect long term care insurance planning. Since every situation has unique circumstances, and laws are subject to interpretation and change, your client should consult with their tax advisor to see how Tax Reform might affect them.  While I’m not licensed to give tax advice, the following information is meant to give a general overview of the recent changes. 

Annually, CLTC publishes a one page Tax Summary (https://ltc-cltc.com/pdf/CLTC-2017-Tax-Guide.pdf), which can help you better understand LTCI deductibility. 

Tax Reform presents a unique opportunity to have an LTCI planning conversation with your clients. Business owners and tax advisors are focused on analyzing the many changes to the tax code. LTCI can be an integral part of that analysis.

First, let’s discuss what appears “not” to have changed…

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) was enacted to satisfy a number of different public policy objectives including: (1) classifying long term care costs as a medical expense thus providing taxpayers with some economic relief; (2) categorizing long term care insurance as accident and health insurance thereby providing clarity as to the tax treatment of premiums and benefits; and (3) providing the general public an incentive to purchase private long term care insurance.

As a result of treating LTCI similar to accident and health insurance, businesses began to provide this valuable benefit to their owners and employees. Businesses can “carve-out” LTCI plans for owners, select employees, their spouses and dependents. Tax-qualified LTCI reimbursement benefits received are generally not includible in income for the employee despite the fact that premiums are deducted by the employer. This differs from other employer paid plans (i.e. disability insurance) where benefits can be taxable to the employee if the premiums were deducted by the business. 

Businesses that file their taxes as C Corporations can generally deduct all LTCI premiums under the plan subject to the requirement that the total compensation is reasonable for services that the employee provides to the business.

Businesses that file their taxes as S Corporations (where income passes through to the owner’s individual tax return) can also deduct premiums paid for LTCI. Like accident and health insurance, LTCI premiums for a two-percent-plus owner in an S Corporation may be claimed as an above-the-line (not itemized) self-employed health insurance deduction on line 29 of the 2017 IRS Form 1040. Two-percent-plus  owners of an S Corporation have an annual dollar limit on the amount of the premium deduction based on the age of the owner during the calendar year when the deduction occurs – limited to the lesser of actual premium paid or eligible LTCI premiums. This tax treatment not only applies to S Corporations, but also Sole Proprietors, Partnerships, and some Professional Service Corporations (i.e. doctors, lawyers, or accountants). 

The precise treatment of the LTCI deduction depends on the type of business entity.

There are changes in Tax Reform that may have an indirect impact on the amount of tax savings related to LTCI deductions. 

1. Changes to the overall tax rates for businesses and individuals
Tax Reform changes both the corporate and individual tax rates. The highest C Corporation tax rate changes from 35 percent to 21 percent and the highest individual tax rate changes from 39.6 percent to 37 percent. Later in this review, we will look at estimated after-tax costs of LTCI plans for a hypothetical client given these new tax rates.

2. Changes to other deductions that might affect LTCI tax savings
The state and local tax itemized deduction for individuals on the federal tax return has been changed under the new law. This could increase federal taxable income especially for those in high income tax states. As such, LTCI deductions may be more desirable than before to take on state income tax returns.

3. Changes to the CPI methodology for the Age Eligible LTCI Premium limits
The age-based annual deductibility limits changed from CPI to “Chained CPI.” This is unlikely to have a major impact. Overall Chained CPI has increased 2.11 percent annually since 2001 as compared to CPI, which has increased 2.33 percent annually. The Age Eligible LTCI limits are linked to the medical care component of CPI.

Inside the Numbers
Different entity types will likely yield different estimated dollar tax savings for a business owner paying LTCI premiums using the corporate checkbook:

• Owner of a C Corporation = Premiums Deducted (not limited) x Corporate Tax Rate.
• Two-percent-plus owners of an S Corporation = An amount equal to the S Corporation’s deducted LTCI premiums is pass-through income to the owner’s individual tax return. The business owner can then deduct the premiums (limited by dollar amount based on age) x Individual Tax Rate. The actual dollar tax savings will depend on many factors related to the owner’s overall individual tax return.

Let’s take a look at an example. A 60 year old couple (business owner and spouse) are looking to implement a long term care plan after having just finished taking care of one of their parents. They learn from their advisor that LTCI can not only provide significant asset protection, but the benefits received are tax-free. Both individuals are very healthy and have been pre-qualified for the best underwriting class. After a conversation to learn about the client’s needs, budget and desires, the advisor designed a long term care insurance plan that will cost approximately $2,500 per person, or $5,000 combined.  

Let’s see how much tax savings they could achieve by deducting the LTCI premiums.

First, let’s assume they own a C Corporation. As a result of Tax Reform, the highest federal corporate tax rate is 21 percent. Their premiums are fully deductible and they could save $1,050 ($5,000 x 21 percent). As a result of this deduction, the net cost of the LTCI plan after tax savings is essentially $3,950. 

Now, let’s assume they own an S Corporation. After Tax Reform their top federal individual tax rate is 37 percent. In 2018, based on their age (60), they are eligible to deduct up to $1,560 per person (or a combined $3,120) based on the Internal Revenue Code Section 213 shown in table 1.

The tax savings could therefore be about $1,154 ($3,120 x 37 percent). When they turn 61 in 2019, the eligible LTCI premium deduction limit may be higher. But, let’s assume that it will still be $4,160 per person (or a combined $8,320 for both of them based on the 2018 limits). They can deduct the combined $5,000 premium in full with a resulting tax savings of $1,850 ($5,000 x 37 percent). As a result of this deduction, the net cost of the LTCI plan after tax savings is essentially $3,150.

An owner of an S Corporation might be able to have a higher dollar tax savings because their individual tax rate is higher than the C Corporation tax rate.

In addition to the advantage of deducting LTCI premiums, using a 10-year premium payment option might maximize this opportunity, and benefit the owner and employees by having the plan fully paid up before retirement.  

In conclusion
Tax Reform, now more than ever, represents a great opportunity to approach tax advisors and business owner clients. There are roughly 28 million small businesses in the US. The potential opportunity within your own network is greater than ever before.

Before April 15: Do you have current LTCI clients that own a business, have long term care insurance, but are possibly not taking advantage of tax deductibility? You can add value to them by educating them on tax savings they might not know are available. 

After April 15: A great time to approach tax advisors! They’ve just completed prior tax year filings and have time to listen to how you can help them and their clients. 

Recently, I was speaking with someone whose CPA had not been utilizing the self-employed LTCI tax deduction on their own tax return!  Don’t let this happen to your clients or their advisors.  Become the go-to person in your community as a resource for everything related to long term care insurance planning.  

If you are aware of other Tax Reform changes that impact LTCI, drop me a note or send me an e-mail.  I’d love to hear from you! 

This is part three of the series on designing affordable LTCI plans using new visualization tools. Part One, Visualizing a Long Term Care Insurance Plan, appeared in the August, 2017, issue, and Part Two,  , appeared in the September, 2017, issue.

In part one of the series we discussed LTCI 2.0—A reboot of LTCI plans designed to protect against the escalating cost of long term care. In part two, we discussed one of the biggest opportunities in LTCI where business owners can often deduct the premiums paid for long term care as a business expense, yet still receive tax-free benefits.

In this conclusion to the three part series, we will bring these concepts into a visual framework that will allow us to analyze the tradeoffs of various funding alternatives to cover long term care expenses. We will also explore the 1035 exchange, a tax-advantaged way to fund LTCI.

Long term care is a risk that we all know needs to be funded. In the absence of LTCI coverage, the burden of long term care can shift to family and friends. For high net worth individuals, setting aside sufficient assets dedicated to pay future long term care expenses is one possible strategy. Unfortunately, self-insuring of future long term care expenses has its limits: Assets currently grow slowly in today’s low interest rate environment, especially if there are taxes to be paid on the accumulating funds.

LTCI plans can be an enhancement to self-insuring. Life/long term care combo products allow acceleration of the death benefit for long term care expenses. The most flexible of these products even provide for extension of LTCI benefits once the death benefit is exhausted. The extended coverage can provide up to three to eight times the premium. The client receives a tax-free death benefit if LTCI benefits are not used. In addition, the policy can be surrendered for a cash payment, typically equal to 80 percent of the premiums paid. These plans are often referred to as “asset-based LTCI.” Although less frequently utilized, there are annuities that can provide an extension of LTCI coverage, but typically only up to three times the premium.

Return of premium riders (ROP) upon death can be added to stand-alone LTCI plans. Functionally, these operate similarly to asset-based LTCI solutions. The ROP provides for all premiums to be paid back to the insured’s beneficiary as a death benefit if not used for long term care expenses. In addition, a cash surrender option can be added that allows the insured to surrender the policy and receive back 80 percent of premiums paid. These plans remove the fear of “use  it or lose it” by providing benefits regardless of whether the client uses long term care, dies, or needs access to the funds. LTCI with ROP has the flexibility to allow richer inflation protection, a full range of premium payment options, and lifetime benefits to provide full long term care risk transfer.

Stand-alone plans today are more robust than legacy LTCI. Rate increases are less likely because of conservative pricing. Paying premiums up front can mitigate the fear of rate increases. Although ROP does not preclude a rate increase, any extra costs would be returned to the beneficiary as an additional death benefit if not used for LTCI benefits. 

Table 1 analyzes the tradeoffs of long term care funding alternatives:

Plans need to be more price stable and still provide value at a reasonable cost to be mainstream solutions. We can assess the value of LTCI coverage using new visualization tools. Let us compare the value of the asset-based plan from Part 1 to the stand-alone plan from Part 2 for the age 50 couple that required long term care services at age 80. We will assume the couple has about $50,000 sitting in a bank account that they have set aside for future long term care expenses.

The couple asks their financial advisor how to most efficiently use the $50,000 to cover the risk of extended long term care expenses:

Option 1: They could self-insure. If we assume a tax-deferred five percent compounded return for 30 years and a 20 percent tax rate at the end of that period, the $50,000 will have accumulated to $182,878 after-tax. 

Option 2: They could purchase an LTCI plan with ROP that provides a combined 15 years of LTCI protection (five years for each insured and an additional five year shared care pool) if they both become chronically ill.  This plan provides up to $891,596 of LTCI benefits. One hundred percent ROP ($50,000) is paid to the beneficiary as a second-to-die death benefit if no care is needed. Eighty percent cash ($40,000) can be returned if they choose to surrender the policy.

Option 3: They could purchase a stand-alone LTCI plan that provides the same 15 years of LTCI protection, but a higher daily benefit amount for the same premium. This plans covers up to $1,486,010 of LTCI benefits, but nothing back if long term care is not used. The plan is guaranteed never to have a rate increase since it is all paid up front in one single premium.

We can visually see the tradeoffs in Chart 2. LTCI with ROP provides about five times the protection of self-insuring and stand-alone LTCI provides about eight times the protection of self-insuring.

Consumers have many choices for valuable LTCI solutions. The earlier advisors and clients plan for long term care needs, the more likely clients will qualify through underwriting. Unfortunately, it is easy to find reasons to delay planning (unless, of course, their advisors or employers utilize LTCI business deductibility).

Fortunately, there is still substantial value even if the clients have waited until closer to retirement. Let us analyze the same scenario, but assume the plan is implemented 10 years later, when they are each 60. We will continue to assume the couple becomes chronically ill at age 80, but now with only 20 years to fund the LTCI plan.

Compared to self-insuring, there is still almost five times the maximum LTCI protection with ROP and almost nine times with stand-alone LTCI as shown in Chart 3.

Given the clients are nearer to retirement, they may have more assets to fund the LTCI plan. This may include cash, investments, life insurance, and annuities. While most LTCI plans are funded with cash, Congress opened the door for new funding sources starting in 2010. The Pension Protection Act (PPA) expanded the definition of tax-free 1035 exchanges to include the use of life insurance or annuity cash values to fund stand-alone LTCI plans.

Many insurance advisors are aware of 1035 exchanges that can fund life/long term care policies from legacy life insurance. However, there is a bigger opportunity that has just begun to be utilized. Using tax-deferred annuities to fund stand-alone LTCI offers the additional benefit that gains in the annuity can now be used to fund the LTCI premium. The gains would normally incur ordinary income tax upon surrender or death. Effectively, the annuity has been exchanged into an LTCI plan that is fully paid up after applying the cash value toward a single premium.

Let us reexamine our age 60 couple who waited 10 years to purchase their LTCI coverage. They own a joint annuity that has a $50,000 cash surrender value, which they purchased several years ago. The annuity had an original cost basis of $25,000 and has accumulated $25,000 of deferred gains. If their income tax rate is 35 percent, the current tax liability on the gains would be $8,800. They can choose to use the full $50,000 through a 1035 exchange to fund an LTCI plan without incurring the $8,800 tax liability. After the exchange is complete, there is almost $1 million of total benefits available under the LTCI plan should they both become chronically ill 20 years later. The value of this approach can be seen visually in Chart 4.

These are many variations on this 1035 exchange theme:

• Although LTCI with ROP can be purchased, a tax advisor needs to be consulted on the tax ramifications of the 1035 exchange after the residual ROP is paid to the designated beneficiary.
• Many types of tax-deferred policies can be used with the primary requirement being that the owner(s) and insured(s) match at the time of the policy exchange.
• Partial exchanges can be taken out of annuities, but a life insurance policy may need to be split first and not have loans outstanding.
• Although annuity or life insurance policies cannot be 1035 exchanged from a qualified vehicle (e.g. 401k or IRA), the after-tax distributions can be used to pay the LTCI premiums.

What a time to become a long term care planning expert. Today, more than ever, clients are acutely aware of the need. LTCI plans can provide a wide variety of customizable solutions. Yet, many financial and tax advisors do not realize that stand-alone plans can deliver tremendous value, mitigate rate increases, receive return of premium, provide tax deduction for business owners, and be funded with annuities, life insurance, or even health savings accounts (HSAs). In fact, middle-market clients in many states are eligible for LTCI policies using state approved partnership programs that match the LTCI benefits received with an equal amount of asset disregard for Medicaid planning purposes. Exploring these new frontiers can provide a significant competitive advantage for insurance advisors seeking to grow their practices. 

This is part two of the series on designing affordable LTCI plans using new visualization tools. Part One Visualizing a Long Term Care Insurance Plan appeared in the August 2017 issue of Broker World.

In part one of the series we discussed LTCI 2.0 – A reboot of LTCI plans designed to mitigate the escalating risk for long term care costs. Let’s run down the list of LTCI objections and recently available solutions shown in table 1:

These last two solutions, Executive Carve Outs and 1035 Exchanges, represent the biggest opportunities in many years to reinvigorate the LTCI market. In this article, I will dive into Executive Carve Outs with new visually interactive tools. I will cover 1035 Exchanges in the next article as part three of this series.

The majority of LTCI planning today occurs between the ages of 45 and 65 as individuals begin to think about their retirement needs. Many have personally experienced caregiving challenges, financing strains, and emotional fatigue from providing long term care for their parents. Most are still in good health. Often, they have just finished raising their own children and paying for family obligations. It is time for them to focus on their own retirement plans. Now is the perfect time to begin the long term care planning conversation.

The children who step forward to plan for the care of the parents are oftentimes successful business people. They have often funded their own qualified investment vehicles such as 401(k) plans to the maximum levels. LTCI is the perfect complement to protect these retirement assets. The risk conversation about outliving wealth has become more relevant in recent years as we have seen a generational change in retirement plans from defined benefit to defined contribution, which shifts longevity risk from corporations to individuals. 

Fortunately, the IRS tax code can come to the rescue. Owing to an underutilized section of the tax code,1 business owners can deduct LTCI premiums as a business expense and still receive their LTCI benefits tax-free. This is unique to the LTCI plan, which is classified as health insurance. This means LTCI enjoys the same benefits for business owners as medical insurance when it is purchased through the business. Unlike disability income insurance, virtually all LTCI policies also enjoy special tax-qualified status, where benefits are generally received tax-free.2  

The opportunity originated from HIPAA in 1996, which clarified the definition and treatment of tax-qualified LTCI. For C-Corporations, the IRS allows full deductibility of LTCI premiums. This means that nearly two million C-Corps can offer LTCI plans to their owners, key executives, and employees without limitations on the deductibility. LTCI plans are allowed to be offered selectively to any or all employees in the organization and their spouses or dependents. Often times, C-Corps will begin by offering these plans just to the owners or key executives. In later years, after observing the value, they roll it out to all employees.

There is an even bigger and mostly unrecognized opportunity that has emerged over the last few years. The 25-30 million small businesses in the U.S., including S-Corporations, Partnerships, and Sole Proprietors can benefit from similar unique tax advantages. This includes small family owned businesses, or professional businesses that doctors, lawyers, or accountants, organize to limit personal liability exposure. The main difference between C-Corporations and these pass-through entities3 is the deduction is limited annually  to the below table in IRC section 213

Today’s tax deductibility under these age based limits is much greater than ever before. This is because the IRS increases these limits annually, based on the healthcare CPI index. On average, the annual increase has been around three percent, but in 2017 the limit increased by five percent. The cumulative effect of 20 years worth of these increases has made small business tax deductibility for LTCI premium more than double its original levels. Simultaneously, the average LTCI premium purchased has stayed relatively constant. This seems surprising to many of those who are not immersed in LTCI sales, yet it is intuitive once you consider that the average purchase today covers three to five year benefit periods instead of lifetime and three percent compound inflation protection instead of five percent.

Let’s revisit the sample age 50 couple from part one of this series. The two individuals were able to purchase significant LTCI coverage, composed of a combined $742,998 of asset protection with return of premium upon death and an 80 percent cash surrender option. The cost was only $1,589 per year for both of them combined. Over the life of the policy, maximum tax-free benefits received were up to 15.6 times the paid premium if both individuals qualified as chronically ill after satisfying their 90-day deductible periods. If the couple did not use their LTCI, they received their premiums back as a return of premium death benefit.

Now let’s assume that the wife is the owner of her small business. She is informed by her insurance advisor that both her and her spouse’s LTCI can be purchased as a tax-deductible business expense just like her health insurance. Also, her insurance coverage will be fully paid-up before she retires by using the 10-pay premium option. If we use the same sample LTCI benefit structure, substitute 10-pay for lifetime pay, and remove the return of premium option, the cost of the plan would be $2,668, now paid only over ten years. Under the new plan design, the couple pre-tax has maximum benefits of up to 27.9 times their cost as shown on the left-side of the graphic (on page 28).

If we assume that the couple’s individual tax rate is 35 percent, they can effectively save an additional 33.5 percent by paying their LTCI premiums using the corporate checkbook! The couple receives the value of up to a total of $742,998 of LTCI benefits with an after-tax cost of only $17,736 as shown on the right-side of the graphic. This results in maximum benefits of up to 41.9 times after-tax. In summary, all except for $1,128 of their premiums may be deducted as a business expense.

Details for this example projected each calendar year are shown below, where the couple deducts the premiums on their joint tax return as a self-employed health insurance deduction (line 29 of the 1040) up to the age eligible limits. The couple is able to deduct $770 per person or $1,540 in calendar year 2017. They can deduct up to $1,530 per person and the full $2,668 in calendar 2018 and beyond. 

An even bigger opportunity is available for business owners as they edge closer to retirement, because they are now allowed to deduct up to $4,090 per person upon reaching age 61. This means they can purchase a policy with over three times as much coverage as the illustrated policy starting at age 61, and still receive the majority of the tax savings. It is difficult to picture a situation where a business owner would choose to self-insure instead of buying LTCI coverage, especially when you project future increases to the IRC section 213 limits.

It is important to distinguish the difference in tax treatment for a small business owner compared to an individual taxpayer. IRC 213 deductions are available on the first dollar of premium for a small business owner as an above the line self-employed deduction. This compares to an individual who would be required to itemize the deduction as a medical expense, which must exceed 10 percent of the taxpayer’s Adjusted Gross Income (AGI) before any is allowed. Even this limited deduction will be minimized if their income is too high or if they fall into the alternative minimum tax bracket.

Keep in mind that customized plan design based on the client’s target budget and needs is the first priority. Paying with the corporate checkbook adds another incentive. The significant extra tax savings is the secret sauce that will encourage the client to finalize their LTC planning this year, so they can begin enjoying the deductibility.

The majority of trusted agents and advisors are unaware that this opportunity exists. The first time they hear about it is a magical aha moment. Just the solution that they have been looking for to protect against the risk that is front of mind. If you can partner with these planning experts, whether they are financial advisors, CPAs, employee benefits advisors, estate planners, tax attorneys, or life/health/P&C agents, this big idea can become a major part of your practice. In fact, you will often find that your first “clients” will be the self-employed independent agents or advisors themselves. Which begs the question, have you considered your long term care plan? 

References

1. US Code 7702B: https://www.law.cornell.edu/uscode/text/26/7702B. IRC Section 105: https://www.law.cornell.edu/uscode/text/26/105. IRC Section 106: https://www.law.cornell.edu/uscode/text/26/106. IRC Section 162: https://www.law.cornell.edu/uscode/text/26/162. IRC Section 213: https://www.law.cornell.edu/uscode/text/26/213
2. Always consult your client’s tax advisor because every tax situation is unique. State and local tax rules may differ.
3. Less than 2% owners of an S-Corp receive the full deductibility of a C-Corp

The first in a three part series on LTCI planning solutions

We are in the midst of a renaissance in long term care planning awareness. Increasing longevity around the world has given virtually everyone a personal experience with someone who can no longer take care of themselves. Alzheimer’s and related dementias, once the unicorn of final outcomes, has become one of the most common causes of death for those experiencing an extended care event. The ongoing discussions in congress about defunding Medicaid have brought to light that most of the government Medicaid spending is for long term care costs—not just those in poverty. Between the direct payments by Medicaid together with the indirect costs of informal caregiving, more than $1 trillion is being allocated annually to long term care. This amount is increasing much faster than the rate of inflation.

Yet, few are aware that there are affordable insurance tools that, together with government incentives, provide the foundation for a solid long term care plan. Traditional LTCI has seen a rebirth where version 2.0 now offers:

• Price guarantees in the form of single pay and risk mitigation with 10-pay options;
• Coverage guarantees with lifetime benefits now available;
• Return of premium options that eliminate the concern of “use it or lose it;”
• Reduced likelihood of rate increases;
• LTCI plans that can be funded like health insurance as a tax deductible business expense; and,
• LTCI plans paid via a 1035 Exchange using existing non-qualified annuity or life insurance cash values where both principal and future deferred tax gains can pay for LTCI premiums.

Life insurance has also experienced a reboot with innovation in a myriad of LTC and chronic illness riders that enhance the core life coverage. In fact, there are now so many options that even a sophisticated financial advisor can face analysis paralysis and end up providing the wrong solution or even none at all.

This makes long term care expertise a valuable asset for those agents and advisors who can bring proactive solutions to their clients. Investments in insurance technology now allow us to take a complex planning concept and break it down into its fundamental parts. Tools exist for the first time that allow agents to visually interact with potential LTCI solutions by instantaneously displaying the value proposition and customizing a plan specific to the client’s budget and needs.

Ever heard an advisor say that LTCI is too expensive? The LTCI plan shown in the chart for a healthy 50 year old couple delivers:

• A combined premium of only $1,589 per year for a five year benefit period for each, with a third five year benefit pool that either or both can use.
• Three percent annual compound inflation protection.
• Up to 15.6 times the paid premium in the form of tax-free benefits if both individuals qualify as chronically ill after satisfying their 90-day deductible periods.
• Return of premium death benefit (second-to-die) with a cash surrender option equal to 80 percent of all premiums paid, if LTCI benefits are not used.
• The option to make payments up front, either in one guaranteed single premium of $42,709 with return of premium included, or $25,574 without the return of premium option.

Take a look again at how affordable the joint premium is for this couple. A comprehensive LTCI solution for less money than this couple might be paying for their term life insurance policies. You can even buy a policy for as little as a few hundred dollars per year that delivers tremendous value. The policy can be designed to be Partnership qualified in most states just by including the three percent inflation option. This allows a much larger Medicaid asset exclusion once the LTCI policy benefits are exhausted. Beyond  the financial benefits, even the most basic policy provides the same rich high end extra features, like help with a plan of care, when the family needs it the most.

LTCI is often perceived as too expensive because many agents and advisors have skipped the initial step of assessing their client’s budget. In the search for a middle market solution, many agents have overlooked the one that currently exists. Amazingly, this solution actually looks similar to the government funded Class Act proposed a few years ago, which was designed to provide a basic $50-100/day benefit. Unfortunately, the Class Act was never implemented because of the fatal design flaw of being guaranteed issue, but using a voluntary purchase design. This may sound familiar to the issues faced today in the proposed changes to the Affordable Care Act.

Luckily, the private market allows us to create a truly affordable plan, by removing the guaranteed issue feature. It only requires trusted advisors to reach out to their healthy clients rather than wait for their less healthy ones to reach out to them. A pool of healthy individuals results in a stable risk pool, which will collectively benefit everyone in the pool. This allows the LTCI planning concept to succeed where the Class Act failed.

Are some of your clients no longer in good health?

This is where innovation outside of traditional LTCI now plays a role. There are several new products ranging from life insurance with long term care riders to chronic illness riders to short term care insurance and, finally, to substandard annuities designed to help stretch the resources of those who cannot qualify for the stand-alone LTCI solutions. These plans complement each other if you or your long term care expert partner first perform a health assessment of the client.  Regardless of your client’s health, there exists a plan for them—even for a client already in poor health or for those already receiving care.

Ever heard an advisor recommend that the client self-insure the LTCI risk?

This probably falls in the category of hoping that it won’t happen, and hope is not a plan at all. Although LTCI now can deliver the full cost of care for an unlimited length of claim, you may want to consider buying a slimmer plan—even for an affluent client.

Consider some of these advantages:

• The family will have guidance at time of claim to construct a plan of care.
• LTCI benefits buy time and leverage with the care provider.
• LTCI benefits are received tax-free.
• Avoiding unexpected costs of selling assets with deferred tax liability or selling illiquid assets at less than their fair market value, such as a home, to pay for care.
• Preserving assets for the healthy spouse or children.
• Premiums may be paid with an implicit tax savings when funding through a business or by using existing non-qualified life insurance or annuity cash values instead of paying with after-tax cash.

Parts two and three of this series will focus on these last concepts where amazing new tax opportunities exist to further incentivize clients to plan for their full LTCI coverage while they still have the most available options.