Understanding The Tax Implications Of Your Long Term Care Insurance

Long term care insurance can be tax qualified or non-tax qualified.  The distinction was defined in 1996 with the Health Insurance Portability and Accountability Act (HIPAA).  In a nut-shell, tax qualified policies allow you to deduct a portion of the premiums paid, and the benefits you receive if you need long term care are not counted as taxable income.  But tax qualified policies are more restrictive in terms of when the benefits will kick in.  Non-tax qualified policies are less restrictive, but the premiums are not tax deductible, and there is no guarantee that benefits won’t be counted as taxable income in the future.

The deductibility of premiums

If you opt for a tax qualified long term care policy, a portion of the premiums you pay will be tax deductible.  But there are restrictions on this.  First, the premiums are considered a medical expense, so the normal rule that allows you to deduct only medical expenses that exceed 7.5% of your income apply.  You can add the long term care premiums to your other qualified medical expenses and whatever portion of that total exceeds 7.5% of your income is deductible.  In addition, the IRS has set limits on the maximum amount of premium that can be included as a medical expense. The amount varies greatly with age, and is adjusted annually.  The limits as of 2010 are as follows:

Age                                          Deductible Premium Limit

40 or under                                              $330

41 – 50                                                      $620

51 – 60                                                      $1230

61 – 70                                                      $3290

71 or over                                                $4110

If you opt for a non-tax qualified long term care policy, no premiums are deductible.

The taxation of benefits

If you have a tax qualified long term care policy, the benefits will not be taxed as income if and when you need them.  Although the immediate deductibility of premiums probably plays a big part in the decision for a lot of people, the fact that benefits are not taxable on a tax qualified policy could end up being a significant benefit.  If you have a policy that provides $200/day in benefits, and you use it for a full year, that amounts to $73,000 in benefits.  If that were to be counted as taxable income, it would result in a rather large tax bill.

Non-tax qualified long term care policy benefits are not currently taxed as income.  But unlike their tax qualified counterparts, there is no guarantee that this arrangement will continue.  The IRS has not ruled on this issue yet, and it remains possible that benefits from a non-tax qualified long term care policy could be taxable in the future.

Policy restrictions

Tax qualified long term care policies are more restrictive in terms of when benefits kick in.  They can not be used for short-term custodial care situations, as you must be in need of care for at least 90 days in order to receive benefits.  In addition, you must be unable to perform at least two of the following activities of daily living (ADL):  eating, bathing, dressing, continence, toileting, and transferring (from a bed to chair or vice versa).

Non-tax qualified policies are less restrictive in this regard.  Some policies include a “medical necessity” trigger, which means that benefits can begin if your doctor states that they are necessary, without the need for assistance with a specific number of ADLs.  In addition, there is no requirement that benefits be needed for at least 90 days.  Non-tax qualified policies also consider walking to be an ADL, and a person who needs help with walking would qualify for benefits even if help is not yet required for the other ADLs.

Cost

Because non-tax qualified policies have fewer restrictions on when benefits can be used, they tend to be more expensive.

If you have questions about long term care insurance options in Colorado, please contact us.  There is never a charge for our services.  If you have questions about the tax implications of a long term care policy in your specific situation, please contact a tax advisor to make sure you are fully aware of all the pros and cons in terms of taxes, before you buy a policy.

**As with any tax issue, we recommend that you discuss the implications for your particular situation with a qualified tax advisor prior to purchasing a long term care policy.  The information provided here is an overview of the general regulations pertaining to taxes and long term care insurance, but it does not replace the need for a tax advisor to assist you in determining how the regulations will impact your specific situation.

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