Clients are always looking to protect their futures. In the case of an unexpected long-term care event, the primary solution for their protection is long-term care insurance (LTCI). That doesn’t mean paying for it is a walk in the park, though.
To pay the LTCI premiums, there’s many routes an advisor and client can go. But let’s throw in another wrench – what’s a tax-efficient way to pay for LTCI?
One potential option – although not for everyone – is to pay LTCI premiums using an annual partial 1035 exchange from a non-qualified, deferred annuity – also known as a fixed-indexed annuity, or FIA.
Before we dive any deeper, always encourage you clients to spend time with both you and their tax professional to go over any insurance needs and to explore all options (ideally tax-efficient) to pay for their LTCI premiums. Now, let’s break down an example.
Sales Strategy: Pay for LTCI Premiums with an Annual Partial 1035 Exchange from a Non-Qualified, Deferred Annuity
Michael, who is age 61, has recently decided that he needs to protect himself and his family in case he endures an unexpected long-term care event. After reaching out to his financial advisor, he understands that self-insuring isn’t for him – leaving LTCI a potential option.
After discussing the policies with his advisor, they compute that the premium needed for Michael’s LTCI is going to cost around $3,000 annually. And even though Michael has over $1 million in total net worth, he wants to find a tax-efficient way to fund his LTCI premiums, without impacting his current cash flow.
His accountant advised him that he’s unable to deduct any of his premiums from his federal income tax return, but Michael remembered his un-needed life insurance policy around $75,000 in cash value, and $100,000 in death benefit.
Ideally, Michael wants to do away with this policy, but at the same time, doesn’t want the roughly $48,000 of taxable gain if he surrenders it. Here’s where the strategy comes in.
Let’s flip the setting. Michael’s “financial advisor” is you. If this was the situation you were dealing with, what’s a tax-efficient way to go about paying for Michael’s LTCI premiums using a non-qualified, deferred annuity?
Here’s the step-by-step approach:
1. First, schedule an appointment with Michael to go over options in-person. It can do wonders for lending trust and allowing your client to feel more comfortable with making a big decision.
2. Once you’re sitting down with your him, explain that there’s a tax-efficient strategy that would allow him to reduce much of the $48,000 taxable gains from his life insurance policy that’s no longer needed.
3. With his approval to reallocate his life policy into LTCI, you’ll want him to apply for an individual LTCI policy with an annual premium of $3,000 – understanding he will be paying his first premium out-of-pocket.
4. Here’s where the fixed-indexed annuity comes in. Now, apply for a fixed-indexed annuity that offers an optional income rider, funding this with a full 1035 tax-free exchange using his life insurance policy. In this situation, a full $73,000 now comes over to the FIA, along with the income rider protection: $25,000 in cost basis, and $48,000 of taxable gain.
5. Flash forward one year, and Michael begins his lifetime withdrawal income that is funded by the annuity and rider. Based on being 62 years old, he gets around $3,700 annually until death. Not only does this cover his LTCI premium, but also gives him an extra $700 in his pocket.
6. Setting up Michael like this, you’ve made it so $3,000 of each payment is sent as a partial 1035 exchange for his LTCI premium payment. Now, some things to note:
- His annuity contract value grew to $75,000 by the time his first payment came
- This makes about a 67% gain in his contract, and 33% in cost basis – making the same percentages applied to his LTCI policy premium
- Without this funding strategy, Michael would have been taxed on the gains transferred over as payment to his LTCI policy.
- The roughly $700 in extra cash flow, however, is taxable.
7. Now that you’ve set Michael up with this premium funding strategy, a partial 1035 exchange is automatically taken from Michael’s annuity to pay for his LTCI premium – while at the same time, a new determination is made as to the gain/basis percentages when the exchange happens.
And that’s it! Pretty nice setup, huh? Now, as years pass, the amount of taxable dollars Michael receives may dwindle through his annual partial exchange, but his LTCI premiums are still getting paid.
Now, as with every strategy, this is not for everyone. But with the right setup and circumstances, this can be an ideal, tax-efficient scenario for certain clients. Which leads to the question…what types of clients can really benefit from this?
Here’s a list:
- Clients that have cash available to purchase a new deferred annuity
- Those who don’t have an alternative to pay their LTCI premiums
- Those who may need guaranteed income and LTCI premium funding
- Clients with remaining cash value life insurance that’s unneeded
- Client who already have LTCI, or have a need for it
- Those that have an existing non-qualified deferred annuity that doesn’t allows for partial exchanges to LTCI
Keep this strategy in mind if you have clients looking for funding for an LTCI policy – it may be time to have a talk about the possibilities of funding LTCI with an FIA.
The information in this article is for informational purposes only and does not constitute legal or tax advice. Customers should consult a legal or tax professional regarding their unique situation. Some information within this article is illustrative in nature. Actual results may vary. Insurance products and related guarantees are based upon the claims paying ability of the insurance company. The concepts within this article are not intended to introduce an insurance replacement strategy. Customers should review their current annuity contracts with their financial professional to ensure they fully understand whether there are any penalties for partial or full exchanges of their existing annuity.