Long-Term Care Insurance from a Tax Perspective

Concerned about care if you should experience a chronic condition or just old age requiring assistance for your daily living activities? You should be, because the cost of long-term care—in your home, an assisted living facility, or a nursing home—can be substantial and generally is not covered by Medicare. Unless your income and assets (technically referred to in government parlance as resources) are very modest, enabling you to rely on Medicaid for assistance, or your income and assets are substantial enough to pay out of pocket for needed care, you probably should consider long-term care insurance to protect the financial position you are in.

Deducting long-term care premiums

Premiums for long-term care coverage are treated as a qualified medical expense, which is deductible as an itemized deduction to the extent total expenses exceed a threshold amount (10% for those under age 65; 7.5% for those 65 and older). However, premiums for long-term care insurance taken into account are limited to a set dollar amount based on your age at the end of the year; the amount taken into account cannot exceed your actual premium payments. For 2014, for example, the dollar limits are:

For example, if you are 62 years old and your annual premium for long-term care coverage is $3,500, your qualified medical expense is $3,500 (even though the dollar limit for your age in 2014 is $3,720).

If you are self-employed, your health insurance is deductible from gross income. The same portion of long-term care premiums for itemizers applies to self-employed individuals. Thus, add long-term care premiums (up to the limit) to basic health coverage to determine the deduction from gross income.

Note: Check state law tax breaks for paying long-term care insurance. A number of states, including Louisiana, Minnesota, Mississippi, New York, North Dakota, and Oregon, let residents take a tax credit (up to a set percentage of the premiums). For example, in Minnesota, the credit is 25% of premiums, but the credit is limited to $100 per beneficiary (e.g., $200 limit if both spouses are covered by a single policy).

Employee benefits

If you enjoy employer-paid health coverage, it is fully tax free. This tax-free treatment applies to long-term care coverage; there is no cap on the exclusion keyed to your age.

However, if your employer has a cafeteria plan in which you can choose among two or more benefits and cash, the plan cannot offer long-term care coverage.

And if you participate in your employer’s medical flexible spending arrangement (FSA), you cannot use your contributions to the FSA to pay for long-term care insurance.

Health savings accounts (HSAs)

If you have an HSA, you can take a distribution to pay long-term care insurance premiums. This is viewed as a tax-free distribution up to the dollar limit discussed earlier.

Accelerated death benefits

If you don’t have a stand-alone long-term care policy, you may be able to use the cash value from a life insurance policy or sell the policy to a life settlement company in order to cover long-term care costs. For those who are terminally ill, there are no adverse tax consequences to this action; the proceeds are tax free to the same extent they would be if a beneficiary had collected proceeds on the death of the insured.

For those who are chronically ill, there may be tax consequences. To be tax free, the accelerated death benefits cannot be more than a per diem limit that is set each year by the IRS ($330 in 2014) and cannot not exceed actual long-term care costs. Any excess amounts are taxable. Form 8853, Archer MSAs and Long-Term Care Contracts, is used to figure taxable payments.

Today, a whole life or universal life insurance policy can be issued with a long-term care rider. However, premiums for the rider are not deductible as are premiums for a stand-alone long-term care policy.

Conclusion

Work with a financial planning professional to determine your long-term care needs and how to best provide for them in the future.