The Hidden Tax Benefits of A “Tax Qualified” Long Term Care Policy

Some readers of this article may have encountered marketing messages for all manner of financial products identified as a “Tax Qualified” Long Term Care policy. In the very complex world of Long Term Care policies, what exactly does this involve?

The term “tax qualified” in this instance refers to a Long Term Care contract that meets the IRS guidelines for potential tax deductibility of the policy premiums as originally defined under the Internal Revenue Code Section 7702B(b) enacted in as part of The Health Insurance Portability and Accountability Act (HIPAA) in August of 1996.

Since the arrival of IRC SEC 7702B(b) on the scene, it has become very difficult to find a Long Term Care policy that is not “tax qualified” because the insurance carriers that offer such policies are looking for every possible means to make policies more affordable to consumers – on a net after tax basis. Being able to deduct premium payments, at least in part, has become a major selling point for such policies.

In addition, some states have initiated either state-level tax deductions or tax credits for the premiums paid by their residents in recognition that the states would prefer individuals to have some level of Long Term Care insurance to help pay for their own care as opposed to turning to state supported Medicaid plans for their later life needs.

For policies purchased by individuals, the IRS deductions themselves are age-based, with older policy owners able to potentially deduct more of their premium costs than can younger policy owners. Furthermore, Long Term Care premiums must be combined with your other medical expenses and itemized on your tax return in order to generate your total medical expense deduction, which applies only to the amount of those expenses that exceed 10% of your Adjusted Gross Income on your return.

As financial advisors, and not licensed tax advisors, the best we can say from here to consult your CPA for more details. Suffice to say, those actual deductions may be challenging to realize, especially now that the IRS Standard Deduction for 2020 has risen to $12,200 for individual filers and then higher for married couples and heads of households, as well as for those over 65.

(Not surprisingly, Long Term Care policies purchased by businesses on behalf of their owners or employees have an entirely different set of deductibility rules, but that discussion may best be left to a later posting.)

But the above part of our discussion relates to the more commonly discussed tax benefits that may accompany the purchase of individual Long Term Care protection, and this article set out to identify the more hidden tax benefits of owning a Long Term Care policy. Those arrive once you may need to make a claim for coverage under your policy. Under a “tax qualified” LTC plan, where the benefits paid out under the plan are not taxed as income to the insured, the maximum benefit an insured may receive is $380 per day. The IRS indexes this amount for inflation, so generally speaking, this daily benefit will increase each year to keep pace with the significant inflation of health care costs.

Thus, any amount you receive in LTC benefits up to that $380 (for year 2020) per diem are not taxed to you as income. And yet, your Long Term Care expenses are generally deductible as per the same rules for itemization of deductible medical expenses discussed above. This is the hidden benefit we wanted to highlight. Your medical expenses can now be deducted against your other sources of income, such as pensions, Social Security, IRA distributions, investment income, rents, and so on.

As an example, even if you are having someone assist you at home for a few hours under the terms of your LTC policy, these costs can add up fast. An aide that charges $20 per hour and works with you for 5 hours per day, every day of the week, and every week of the year will cost you $36,400 for the year. You can typically pay that aide with the benefits from your policy, but those benefits do NOT add to your taxable income.

Therefore, if you have Adjusted Gross Income (AGI) from all sources combined of $100,000, you can deduct all medical expenses above 10% of your AGI; in this case $10,000. That leaves $26,400 of deductible medical expenses, far exceeding the Standard Deduction of $12,200, and which will then reduce your taxable income right off the top by more than 25%. Add in all the rest of your medical expenses for that tax year, and you can save even more. And all else being equal, a lower AGI would result in an even larger percentage tax reduction.

We promised that there was a substantial – albeit hidden – tax benefit that can be derived from a “Tax Qualified” Long Term Care policy, and there it is. As with any discussion of taxes, we saw here that once you get into it, the complexities of the tax code can compound themselves in a heartbeat. At Guideboat Financial, we welcome your inquiries on this particularly challenging topic, no matter where you may live, and even if you think you may eventually want to work with an advisor closer to home. Our goal is to help you be better informed about the financial products and services that can make such a major contribution to your lives and the lives of those you care about most.

Guideboat Financial

Christopher Burke, Principal

chris@guideboatfinancial.com