Long-term care is expensive, and the cost of long-term care may quickly deplete your savings while also impacting your quality of life. Long-term care insurance absorbs part of the expense, so you don’t have to pay it all on your own. However, long-term care insurance premiums are costly and can increase over time. One solution is to exchange your annuity contract for a long-term care annuity.
Withdrawals from a nonqualified deferred annuity (after-taxed money) are considered to come first out of earnings, then out of the contract’s initial investment premium. This tax method is called Last In, First Out, or LIFO. The earnings portion of the withdrawal is considered taxable income to the annuitant.
However, IRC Section 1035 allows you to exchange one annuity for another without immediate tax consequences, as long as specific requirements are met. As of January 1, 2010, the Pension Protection Act (PPA) allows both life insurance and annuities to be exchanged, tax-free, for qualified long-term care insurance policy such as a long-term care annuity.
How To 1035 Exchange An Annuity To A Long Term Care Insurance Annuity
For the transfer of an annuity to a long-term care insurance policy to be classified as a tax-free exchange, certain criteria must be met:
- First, the annuity must be nonqualified.
- The exchange must happen directly between insurance companies. You will not get a tax break if you withdraw money from your annuity and then use it to pay for your long-term care insurance. The annuity application will include a 1035 Exchange Form.
Advantages and Disadvantages
- Annuity payments may be used to pay for long-term care insurance without incurring income tax.
- Using an annuity to pay for long-term care insurance may help you avoid having to tap other assets or income to cover premiums. A long-term care annuity will either double or triple your annuity’s value to pay for long-term care expenses.
- You still maintain a cash surrender value of the annuity in case you change your mind.
- If you exchange the annuity for a long-term care insurance annuity, your beneficiaries will have the annuity’s cash value for an inheritance that otherwise would have been available at your death.
A surrender charge may be applied when an annuity is exchanged, reducing the annuity’s value. However, if the annuity is out of the surrender term, there is no surrender charge.
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