Put Life, LTC Insurance On Retirement Planning Menu

Reason: should the person need life insurance later in life, he or she may no longer be insurable at a reasonable cost, if at all. Plus, there's a taxable event to consider. Surrendering the life policy will trigger income tax on the inside build-up within the policy.

Of course, people should not keep a life policy solely for tax reasons, but there may be a tax-wise strategy for unlocking the policy's tax liability over time so it coordinates with the retirement plan.

Given that one's likelihood of needing long term care increases with age, purchasing an LTC policy should also be an important consideration. Assuming that people cannot afford to self-insure this risk and don't want to spend down assets to become eligible for Medicaid, such insurance may be a good way to manage the risk of significant LTC expenses. An LTC policy can also serve as protection against erosion of an estate intended for children or other heirs.

For many, though, the cost of LTC insurance is prohibitive. One funding alternative is a life insurance contract that no longer meets the person's current needs. Starting in 2010, an individual can exchange a life policy for an LTC policy–and avoid paying income tax on the gain in the life insurance contract.

Example: A life policy with $100,000 of cash surrender value and a tax basis of $50,000 can be exchanged for a single premium LTC policy with a $100,000 premium. Prior to the change in law, the person would have to pay tax on the $50,000 of gain in the life policy, reducing the amount available to purchase LTC insurance by approximately $20,000 (assuming the $50,000 gain is subject to federal and state income tax at a rate of 40%). Of course, it's critical to determine whether the person's insurance needs have indeed changed. If he or she no longer needs the life insurance but does need LTC insurance, however, the life policy's cash value can be used to purchase an LTC contract.

Another solution might be to buy an LTC policy with a lengthy elimination period–that is, the period between when the need for LTC arises and when the LTC coverage begins. This will reduce the cost yet still provide a type of limited stop-loss protection in the event the LTC need exceeds the lengthy elimination period. While this may not be the ideal solution, some LTC protection is better than none in managing what could turn out to be a very significant expense.

Robert Fishbein is vice president and corporate counsel in the tax department of Prudential Financial, Newark, N.J. His email address is