Use Your Annuity to Pay for Long-Term Care Insurance

The cost of long-term care can quickly deplete your savings and affect the quality of life for you and your family. Long-term care insurance allows you to share that cost with an insurance company. But premiums for long-term care insurance can be expensive, and cash or income to cover those premiums may not be readily available. One option is to exchange your annuity contract for a long-term care insurance policy.

Section 1035 exchange

Generally, withdrawals from a nonqualified deferred annuity (premiums paid with after-tax dollars) are considered to come first from earnings, then from your investment (premiums paid) in the contract. The earnings portion of the withdrawal is treated as income to the annuity owner, subject to ordinary income taxes. IRC Section 1035 allows you to exchange one annuity for another without any immediate tax consequences, as long as certain requirements are met. However, prior to 2010, an annuity couldn’t be exchanged for a long-term care insurance policy on a tax-free basis. But the Pension Protection Act (PPA) changed that and, as of January 1, 2010, both life insurance and annuities may be exchanged, tax free, for qualified long-term care insurance.

Conditions for tax-free exchange

In order for the transfer of the annuity to the long-term care insurance policy to be treated as a tax-free exchange, certain conditions must be met:

  • The annuity must be nonqualified, meaning it cannot be part of an employer-sponsored retirement plan. For example, a tax-sheltered annuity or an annuity used to fund an IRA would not qualify for tax-free exchange treatment.
  • The long-term care insurance policy must meet the requirements of the Health Insurance Portability and Accountability Act (HIPPA) and IRS criteria. Generally, the long-term care insurance policy must provide coverage only for qualified long-term care services; it must be guaranteed renewable; it cannot have a cash surrender value; refunds or dividends can only be used to reduce future premiums; and policy benefits cannot pay for expenses covered by Medicare (except where Medicare is a secondary payee).
  • The exchange must be made directly from the annuity issuer to the long-term care insurance company. You will not receive tax-free treatment if you withdraw funds from the annuity directly, then use them to pay the long-term care insurance premium.

Presuming these criteria are met, exchanging an annuity for a long-term care policy can be done in one of two ways: a full transfer of the entire cash surrender value of the annuity in exchange for the long-term care insurance policy; or partial exchanges of the annuity’s cash value for the long-term care policy. Not all insurance companies allow long-term care policies to be funded with a single, lump-sum payment, so the more common approach may be to pay long-term care insurance premiums through several partial exchanges from the annuity.

Potential tax advantages

Exchanging your nonqualified deferred annuity for a long-term care insurance policy may have several tax-related advantages. You can use annuity earnings to pay for long-term care insurance without paying income tax on those earnings. This allows you to use otherwise taxable annuity earnings in a more tax-efficient manner.

According to the IRS, Section 1035 exchanges from a nonqualified annuity to pay for tax-qualified long-term care insurance are pro-rated based on the comparative percentages of principal and earnings in the annuity. For example, say you have a nonqualified annuity worth $100,000, which includes your premium of $50,000, plus earnings worth $50,000, and you haven’t taken any previous withdrawals. You direct the annuity issuer to send $2,500 to the long-term care insurance carrier as a partial exchange to pay for insurance premiums. Your annuity cash value is reduced by $2,500, but half of that amount ($1,250) comes from earnings. As a result, not only have you withdrawn annuity earnings ($1,250) without paying taxes on them, but you have further reduced the taxable portion of your annuity by $1,250. By withdrawing earnings from your annuity to pay for long-term care insurance, you could reduce the taxable portion of your annuity, which can be important if you surrender the annuity later.

Another advantage relates to the long-term care insurance policy. Generally, a qualified long-term care insurance policy is treated as an accident and health insurance contract, and the benefits are typically treated as tax free, subject to certain limits. In this way, you may be able to use tax-free annuity earnings to pay for tax-free long-term care benefits.

Other possible benefits

Aside from the favorable tax treatment, there may be other benefits as well.

  • Using an annuity to pay for long-term care insurance may lessen the need to tap other savings or income to pay for premiums.
  • You may still use any remaining cash surrender value of the annuity for other income needs or expenses.
  • Exchanging the annuity for long-term care insurance may better meet your current needs, financial situation, and preferences.

Some potential disadvantages

There are also some potential disadvantages to exchanging an annuity for long-term care insurance.

  • Annuity surrender charges might be incurred on the exchange of the annuity, thus reducing the annuity’s value.
  • Reducing the annuity’s value to pay for long-term care insurance premiums may reduce your ability to use the annuity to provide income needed in the future.
  • Some nonqualified deferred annuities might not be eligible for a partial Section 1035 exchange because the annuity contracts may not allow annuity payments to be made to other than the annuity owner (e.g., annuity payments cannot be assigned to another payee).
  • If you exchange the annuity for a long-term care insurance policy, your survivors won’t have the annuity’s cash value for income or savings that otherwise would have been available at your death.
  • Generally, premiums for qualified long-term care insurance are deductible as qualified medical expenses subject to certain restrictions. The tax savings of using a tax-free Section 1035 exchange needs to be compared to available federal or state income tax deductions for long-term care insurance premiums. Depending on your situation, it might be more beneficial to deduct premiums and include annuity earnings as taxable income.

Frequently asked questions

If I am the sole owner of the annuity, can I exchange it for a long-term care insurance policy jointly owned by my spouse and me?

Generally, no, because the owners of both the annuity and the long-term care insurance policy must be the same. However, you may be able to change the ownership of your annuity to include your spouse. While changing ownership of an annuity is generally treated as a taxable event to the extent of gain (earnings) in the annuity, ownership changes between spouses are typically tax free, but be sure to consult your tax or financial professional before making ownership changes to your annuity.

I’m receiving payments from a nonqualified immediate annuity. Can I exchange these payments for long-term care insurance?

You may be able to assign the payments directly to the long-term care insurance company as a 1035 exchange, but the annuity payee must be the long-term care insurance company–if you’re listed as the payee, payments will not receive tax-free treatment. Also, be aware that if long-term care insurance premiums increase, the annuity payments may not be sufficient to cover the cost of the long-term care insurance premiums. Also, if the annuity payment exceeds the insurance premium, you may be able to split the annuity payment, where an amount equal to the insurance premium is sent to the long-term care insurance company and the balance of the annuity payment is sent to you, but this would be at the discretion of the annuity issuer.

Can I use more than one annuity to pay for long-term care insurance?

Generally, yes, because funds from one or more nonqualified annuities can be exchanged for a long-term care insurance policy.

 

 

 

 

 

 

 

 

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of Albert Aizin, and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, Hughes, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Northrop Grumman, Raytheon, ExxonMobil, Merck, Pfizer, Glaxosmithkline, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Albert Aizin is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.

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A Business Plan Can Be Your Guide to Growth

Whether you’re a current business owner or a budding entrepreneur burning with the next great idea, one of the most important steps you can take on your road to success is creating a business plan. Why? A well-thought-out and well-written business plan captures your vision, illustrates it for others (including potential lenders and investors), and creates the roadmap you and your management team need to guide you through the growth of your business. Consider the following points:

  • If you’re a current business owner, you probably feel like you’re always working to close the next big deal, juggling financials, or responding to the latest crisis. Remember, however, that it’s important to periodically climb out of the trees and take a good, hard look at the forest. A business plan can help you do just that: take stock of where you’ve been and lay the groundwork for where you’re headed.
  • If you’re a budding entrepreneur, a business plan can help you raise money. It will help prove to potential investors and lenders that your idea is worth funding.
  • For both current and potential business owners, the process of creating a business plan can prove beneficial by revealing potential risks and uncovering opportunities that may not otherwise be apparent.

A business plan should be comprehensive, yet as concise as possible. Although there are no limits to the length, a business plan should respect the time of your readers while providing the information they need to make important decisions. Before you begin writing, consider contacting an attorney or business consultant with expertise in business plan writing. Following are some of the main components of a business plan.

Cover page and table of contents

The cover page is simply a title page for your business plan document. It should include the name of the company, address, phone number, owners’ names, and contact information. It should also include the date on which the document was finalized and published. The table of contents helps readers navigate through the document and identifies page numbers for each of the sections.

Executive summary

The executive summary is essentially your elevator pitch–an abridged version of the business plan that describes to readers why your business is worthy of their attention and possibly their money. It should be no longer than one page, but should contain all pertinent details. For this reason, it is often easier to write this section last.

An executive summary should answer readers’ primary questions–i.e., are you looking for funding, is the document a strategic guidebook for management, or both? As you draft your executive summary, keep in mind that many readers will decide whether the subsequent pages are worth reviewing based on this important section.

Business description

The business description is the first major section of your business plan and should provide more details on the nature of your business. One paragraph should outline the key elements of your business, and then subsequent paragraphs might expand on each. These elements should include:

Product or service description

Describe in detail the product sold or service provided. If you are producing a product, explain how the product is manufactured. What materials are used? Who are your suppliers? What are the costs of production? If you provide a service, describe what it is and why it is different. How will it be provided? In this section, you might also address potential pitfalls and how they will be addressed. For example, if demand for your product or service is higher than expected, how will you manage the volume?

Legal structure

Business entities come in a wide variety of legal structures, ranging from sole proprietorships and partnerships to corporations. Each has its own pros and cons. In this section of the business plan, you’ll need to describe the entity you selected and the reasons for your decision. Include supporting documentation (e.g., a partnership agreement).

Business and industry description

Who are your key advisors and managers, and how does their experience benefit your organization? Where are you located and why did you choose this location? You might also want to use this section to describe the genesis of your business–i.e., how and why you decided to launch the venture. Provide details on the industry you are in and why your business has a competitive edge. Include relevant data and illustrations, if applicable. (For example, a retail establishment might include a map highlighting strong pedestrian traffic patterns in the area.)

Market analysis and marketing strategy

Perhaps the most influential section of your business plan, the market analysis and marketing strategy sections are where you convince readers that your business will be successful.

The market analysis section should provide a specific and detailed analysis of your target market, including what you have done to maximize your opportunity within it. Who are your current and potential customers, and why? Summarize any market research you have conducted to prove the viability of your business. How big is your potential market? Who are the major competitors?

If your business plan is intended for potential investors or lenders, this section will help convince them that you truly understand your market and are an expert in your industry. If your plan is primarily designed to educate key employees, it will provide the basic information they need to strategize and carry out your vision for growth.

Once you have conducted thorough market research, the next step is to brainstorm how you will market your product or service within your industry. This marketing strategy section of the business plan should provide details about how you will promote your products and services. How will you differentiate yourself from the competition within your target market? What is your business’s value proposition (i.e., the unique value your company offers the marketplace), and how will you communicate it to your stakeholders? Describe any marketing tactics, such as advertising and public relations, as well as sales models and sales compensation structures.

While the market analysis and marketing strategy sections may be the most time-consuming to put together, they will be well worth the effort. Conducting thorough market research can uncover previously unknown challenges and opportunities. Addressing these findings with a creative strategy can give your business a competitive edge. It can also help your business’s leadership team understand the reasons for certain strategic decisions you make that they may not necessarily agree with.

Financials

Of particular importance to potential investors and lenders, the financials portion of the business plan is designed to help your readers understand where you are now financially, and where you hope to be. If you are seeking money, this section should outline exactly how much you need and why. You should include all current and projected (or “pro forma”) financial statements, including:

  • Cash flow statement
  • Balance sheet
  • Income (or profit and loss) statement
  • Break-even analysis

This section will likely be scrutinized the most, so be sure it is completed carefully. Some readers will require more information than others. What is most important is that the information provided is accurate and well-supported with documentation. The main purpose of this section is to educate readers about the use of resources–including any debt and equity financing you hope to get–proving to them that you and your leadership team can and will manage money effectively.

Worth the effort

Most business owners would much rather focus on their daily objectives and challenges than take valuable time away from their business to write a business plan. But in the end, it will be worth the effort. A business plan is not only important, but it can also become a critical resource on your journey toward success. For more information, visit the Small Business Administration, www.sba.gov.

 

Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not
specific to any individual’s personal circumstances. Securities offered through FSC Securities Corporation, member FINRA / SIPC . Investment advisory services offered through The Retirement Group, LLC, a registered investment advisor which is not affiliated with FSC Securities Corp.     To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose
of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her
individual circumstances.These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.