How is Long Term Care Insurance Taxed?

At the individual level, long term care insurance premiums are usually at least partly deductible, provided you use the 1040 form. You
can’t use the Form 1040EZ or the 1040A. Specifically, premiums are deductible
to the extent they exceed 7.5 percent of your adjusted gross income, as noted
on your individual income tax return.

You don’t get to use a “Cadillac” long term care insurance policy as a tax-shelter though: Congress has set a cap on the level of benefits you can buy and still take the tax deduction. However, the dollar amount of premium you can deduct increases as you age, and applies to all long-term care insurance policies considered “tax-qualified” by the IRS.

  • Policies are guaranteed renewable, regardless of your medical condition.
  • The policy must provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract must be used only to reduce future premiums or increase future benefits.
  • Policies pay benefits when you lose the ability to perform, unassisted or unsupervised, at least two activities of daily living, such as bathing, transferring, dressing, toileting, continence or eating, or if you are diagnosed with a severe cognitive disorder, such as dementia or Alzheimer’s disease.
  • The plan of care is provided under the direction of a medical professional.
  • Generally, a tax-qualified policy does not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer, or the contract makes per diem or other periodic payments without regard to expenses.

As of 2012, the annual limits on tax deductibility are as follows:

  • Taxpayer’s Age (At End of Tax Year) – Deductible Limit
  • 40 or less:$350
  • More than 40 but not more than 50: $660
  • More than 50 but not more than 60: $1,310
  • More than 60 but not more than 70: $3,500
  • More than 70: $4,370

These limits are indexed to inflation, so they have the potential to increase each year.

Example:

Suppose a couple, Mark, age 55, and Louise, 50, buy a long-term care insurance policy on each of them. Their overall medical expenses add up to to 7.5 percent of their annual income, so they are able to deduct the cost of their long-term care premiums over and above their other medical expenses.

The amount of long term care premiums the older spouse can deduct, exceeding
7.5 percent of AGI for the year is $1,310. Louise can deduct up to $660. But
next year, Louise will be age 51, and will fall into the next age category.
They can both deduct the maximum amount for 2013 – $1,310 each, plus an
adjustment for inflation.

Note: If you have to pay alternative minimum tax, you will have a 10 percent threshold, rather than a 7.5 percent threshold for your medical expenses as a percentage of your AGI. You are also likely to lose some of your other deductions, as well.

Health Savings Accounts and High-Deductible Health Plans

If you use a health savings account, you can use tax-free dollars to pay your long-term care insurance premiums, up to the annual health savings account limit. You do this by contributing an amount sufficient to cover your premium to your HSA, and then paying the LTC premium from your HSA. You can only own an HSA, however, if you also have a qualified High-Deductible Health Plan. Consult your agent for specific details on these plans.

How Are Benefits Taxed?

All benefits your LTC insurance policy pays to providers are tax-free to you. If your plan pays you, rather than your providers (an “indemnity plan”), your benefits are free of income tax, up to a limit of $310 per day, as of 2012. The cap on tax-free benefits is adjusted for inflation every year, so that cap also has the possibility of increasing.

About Brian Hendricks

Brian Hendricks is the President of Fidelity Insurance Group. Brian started Fidelity in 2003 with 0 clients. Today Fidelity Insurance Group is a Premier Independent Insurance Agency in Florida with over 3,000 families and businesses insured. Brian currently serves on advisory boards for 2 of the largest property insurance companies in Florida. Knowlege, Integrity, and Committment are his and his agency's guiding principles.
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