Would you like to save more money on taxes? Most of us would. And most of us are not aware of the ways long-term care planning, and long-term care insurance, can change the tax picture.
The dollar you already spend
In most cases we pay for things in one of two ways. We pay with income: earn a dollar, pay tax on it, and have something like 70 or 80 cents left to spend. Or we pay with savings and investments. A withdrawal from an IRA, or a gain in a stock, mutual fund or ETF, is taxed at capital-gains rates or, for an IRA, as ordinary income. Again, the dollar we need for care arrives as less than a dollar.
I call that a de-leveraged dollar. You want a dollar, and taxes leave you with less.
What the insurance pool does instead
A long-term care policy is built around a pool of care dollars. However large that pool becomes, the insurance company's payments for qualified care are not taxed as income to you. No income tax, no state tax, and they do not count as income on the return.
Example: Margaret puts $100,000 into a policy, as one payment or over 10 years. It is common for the pool to start around $300,000 and to grow, in this illustration, toward $500,000 by the time she needs care. Tax on that $500,000 as it is paid for her monthly costs: zero. The amount above her premium is insurance-company money, paid for care, tax free.
And the $100,000 becoming $300,000 at the start is leverage. One dollar turns into three, and can grow from there. Compare that with spending your own income or assets, where a dollar becomes 70 or 80 cents.
Other tax points worth asking about
- Premiums may be deductible. A business owner usually has a clearer deduction. Someone who is not a business owner might still have one. That is a question for your accountant.
- Growth inside the care pool does not produce taxable income the way investment growth can.
- Hybrid policies we use include a death benefit. Depending on the policy, that benefit can be tax free, or the growth above the premium can be tax-deferred and then taxable to heirs.
- An old life policy, including one with cash value, can sometimes be moved into a tax-free long-term care policy and leveraged up, so the care payments are not taxed.
- An old non-IRA annuity can sometimes be exchanged, tax free, into a long-term care policy, turning a heavily taxed annuity into a tax-free pool of care money.
- On an older “use it or lose it” policy, ask whether the annual premium is being deducted. For some taxpayers that is an above-the-line deduction.
- For business owners, both you and your spouse may be able to deduct long-term care premiums above the line. Your accountant may know some of this and not all of it. Work as a team.
These are illustrations from my practice, not a promise that any one policy, deduction or exchange is available to you. The numbers depend on the contract, the state and the tax year.