General Rules Of Long Term Care Insurance

March 13, 2024

477 / What is a qualified long-term care insurance contract?

<div class="Section1">Editor’s Note: Section 344 of the SECURE Act 2.0 will allow taxpayers to withdraw up to $2,500 each year from retirement accounts to cover the costs of long-term care insurance without triggering the 10% early withdrawal penalty (these withdrawals will still be subject to ordinary income taxation). The funds can be used to pay for standalone long-term care insurance or for certain life insurance or annuity contracts that also provide for meaningful financial assistance in the event that the insured person requires long-term care in a nursing home or home-based long-term care. This new provision is effective for tax years beginning after December 31, 2024 (the $2,500 annual limit will also be adjusted for inflation).<div class="Section1"> A long-term care insurance policy issued after 1996 is a qualified long-term care insurance contract under IRC Section 7702B(b) if: <blockquote>(1)     The only insurance protection provided under the contract is coverage of qualified long-term care services ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="481">481</a>);</blockquote> <hr> Planning Point: Although this is one of the foundational principles of qualified long-term care insurance, there is a notable exception to this rule. Since 1996 there have been scores of policy designs which pay either an indemnity (i.e., the full daily or monthly benefit without regard to costs incurred) or a cash benefit (i.e., some flat amount based solely on the insured’s ability to trigger benefits—without even the prerequisite that services have been received.) Such designs are permitted under 7702B(2)A, which permits “per diem” payments without otherwise contradicting this principle. <hr> <blockquote>(2)     The contract does not pay or reimburse expenses incurred for services that are reimbursable under Title XVIII of the Social Security Act or that would be reimbursable but for the application of a deductible or coinsurance amount;</blockquote> <hr> Planning Point: This paragraph refers to Medicare, which may pay for limited home health care benefits, and—subject to gatekeepers—a limited skilled nursing facility benefit as well (no more than 100 days). Prior to HIPAA, long-term care insurance policies were permitted to “duplicate” Medicare (assuming any were received by the policyholder). After HIPAA, tax-qualified (TQ) plans had to “coordinate” with Medicare. <hr> <blockquote>As a result of the relatively confounding manner in which this section of the regulation is written, many producers have wondered: on the chance Medicare does pay for nursing facility care on days 1 – 100, can the LTCI policy pay anything? The answer is: yes, a TQ plan can reimburse for any charges over and above what Medicare pays. Nevertheless, either believing that it cannot, or that Medicare pays much more frequently than it does, most producers overwhelmingly sell a 90- or 100-day elimination period (in approximately nine out of 10 policies). (3)     The contract is guaranteed renewable;</blockquote> <hr> Planning Point: Guaranteed renewability means the insurer must not fail to renew a policy if premiums are timely paid. The insurer may not single out any policyholder for a rate increase solely because they grew older, get sick, or file a claim. Unfortunately, many consumers have interpreted this to mean their rates would never increase. That’s not the case. <hr> <blockquote>“Guaranteed Renewable” policies do permit the insurer to file a rate increase request, by state, by policy form, and by “class” (e.g., those with compound inflation protection might be a different class than those without).</blockquote> <hr> Planning Point: TQ plans may also be “non-cancellable”, although many think the re-appearance of such designs highly unlikely.<a href="#_ftn1" name="_ftnref1">1</a> <hr> <blockquote>(4)     The contract does not provide for a cash surrender value or other money that can be paid, assigned, or pledged as collateral for a loan or borrowed; and (5)     All premium refunds and dividends under the contract are to be applied as a reduction in future premiums or to increase future benefits. An exception to this rule is for a refund made on the death of an insured or on a complete surrender or cancellation of a contract that cannot exceed the aggregate premiums paid. Any refund given on cancellation or complete surrender of a policy will be includable in income to the extent that any deduction or exclusion was allowable with respect to the premiums.<a href="#_ftn2" name="_ftnref2">2</a></blockquote> <hr> Planning Point: Premium refunds paid on the insured’s death are generally not taxable income to the beneficiary or estate. <hr> In addition, a contract must satisfy certain consumer protection provisions concerning model regulation and model act provisions, disclosure, and nonforfeitability.<a href="#_ftn3" name="_ftnref3">3</a> A policy will be considered to meet the disclosure requirements if the issuer of the policy discloses in the policy and in the required outline of coverage that the policy is intended to be a qualified long-term care insurance contract under IRC Section 7702B(b).<a href="#_ftn4" name="_ftnref4">4</a> The nonforfeiture requirement is met for any level premium contract if the issuer of the contract offers to the policyholder, including any group policyholder, a non-forfeiture provision that: <blockquote>(1)     Is appropriately captioned; (2)     Provides for a benefit available in the event of a default in the payment of any premiums and the amount of the benefit may be adjusted only as necessary to reflect changes in claims, persistency, and interest as reflected in changes in rates for premium paying contracts approved for the same contract form; and (3)     Provides for at least one of reduced paid-up insurance, extended term insurance, shortened benefit period, or other similar approved offerings.<a href="#_ftn5" name="_ftnref5">5</a></blockquote> <hr> Planning Point: The standard non-forfeiture benefit is one of the all-time least popular benefits, almost never elected. It generally provides that—should a policyholder lapse any time after the first three years due to non-payment—they will still be entitled to claim against a “pool of money” the size of their aggregate premiums paid (but not less than 30 times the daily benefit). The hitch is that additional premium is required for this rider, the cost of which never makes sense when compared to the paltry benefit conferred. <hr> A qualified long-term care insurance contract that is approved must be delivered to a policyholder within 30 days of the approval date.<a href="#_ftn6" name="_ftnref6">6</a> If a claim under a qualified long-term care insurance contract is denied, the issuer must provide a written explanation of the reasons for the denial and make available all information relating to the denial within 60 days of a written request from a policyholder.<a href="#_ftn7" name="_ftnref7">7</a> <hr> Planning Point: This regulation suggests the need for policy delivery receipts. Although not all states require them, and not all carriers employ them, they do provide liability protection by proving one’s policy has been timely delivered. (At which point, the clock starts on the 30 day “free look” period.) <hr> For the treatment of long-term care insurance contracts issued before 1997, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="482">482</a>. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 7702B(g). <a href="#_ftnref2" name="_ftn2">2</a>.     IRC § 7702B(b)(2)(C). <a href="#_ftnref3" name="_ftn3">3</a>.     IRC § 7702B(g). <a href="#_ftnref4" name="_ftn4">4</a>.     IRC § 4980C(d). <a href="#_ftnref5" name="_ftn5">5</a>.     IRC § 7702B(g)(4). <a href="#_ftnref6" name="_ftn6">6</a>.     IRC § 4980C(c)(2). <a href="#_ftnref7" name="_ftn7">7</a>.     IRC § 4980C(c)(3). </div></div>

March 13, 2024

479 / Can long-term care insurance be provided under a cafeteria plan or through the use of a health savings account or flexible spending arrangement?

<div class="Section1">Qualified long-term care insurance (QLTCI) premiums cannot be reimbursed through a flexible spending arrangement (FSA). Similarly, QLTCI policies cannot be purchased with pre-tax dollars through an employer-provided cafeteria plan (Section 125(f)(2)).</div> <div class="Section1"> On the other hand, health savings accounts (HSAs) present an excellent opportunity to pay for QLTCI premiums on a tax-advantaged basis. Subject to limitations, contributions to an HSA are not subject to federal income tax. Earnings and distributions from an HSA are tax-free if used to pay for qualified medical expenses. Since qualified long-term care premiums are deemed a qualified medical expense, they comprise an allowable withdrawal from an HSA. However, the tax-free amount is limited to “qualified LTCI premiums,” which are defined as the lesser of actual premiums paid or the “age-based” limits from the table below. <table> <tbody> <tr> <td style="text-align: center;" colspan="2" width="539">Age-Based LTCI Premiums (IRC Section 213(d)(10)(A))</td> </tr> <tr> <td style="text-align: center;" width="270">Age at End of Tax Year</td> <td style="text-align: center;" width="270">2025 Premium Limit</td> </tr> <tr> <td style="text-align: center;" width="270">40 or Less</td> <td style="text-align: center;" width="270">$480</td> </tr> <tr> <td style="text-align: center;" width="270">41 – 50</td> <td style="text-align: center;" width="270">$900</td> </tr> <tr> <td style="text-align: center;" width="270">51 – 60</td> <td style="text-align: center;" width="270">$1,800</td> </tr> <tr> <td style="text-align: center;" width="270">61 – 70</td> <td style="text-align: center;" width="270">$4,810</td> </tr> <tr> <td style="text-align: center;" width="270">71 and Older</td> <td style="text-align: center;" width="270">$6,010</td> </tr> </tbody> </table> If one’s premiums were greater than the limits in the table, the balance would have to be paid with non-HSA funds; otherwise, amounts withdrawn from an HSA for ineligible expenses are subject to income tax and a 20 percent penalty (those who are disabled, deceased or over age 65 are exempt from the penalty). <hr /> Planning Point: An HSA may be set-up through a cafeteria plan. <hr /> </div>

March 13, 2024

481 / What are qualified long-term care services?

<div class="Section1"> Qualified long-term care services are any necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services that are 1) required by a chronically ill individual and 2) provided under a plan of care set forth by a licensed health care practitioner.<a href="#_ftn1" name="_ftnref1">1</a> <hr /> Practice Point: A licensed healthcare practitioner can be a physician, registered nurse or licensed social worker. <hr /> A chronically ill individual is a person who has been certified by a licensed health care practitioner as 1) being unable to perform, without substantial assistance from another individual, at least two activities of daily living (“ADLs”) for at least 90 days due to a loss of functional capacity, 2) requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment, or 3) having a level of disability similar to the level described in (1) above, as determined by the Secretary of Health and Human Services. In all cases, a licensed healthcare practitioner must have certified the need for such requirements within the preceding 12 months. <hr /> Practice Point: Prior to 1997, benefit triggers in long-term care insurance policies were not standardized, but this should not be taken to mean that common triggers weren’t widely found, including those described above. The significance of HIPAA in creating tax-qualified (TQ) policies was thjollowing: <blockquote>1. Eliminating the “medical necessity” trigger, and 2. Creating the 90-day certification requirement.</blockquote> <hr /> The 90-day requirement for the ADL benefit trigger does not establish a waiting period (i.e., elimination period), but simply a duration over which the individual’s disability is certified to last.<a href="#_ftn2" name="_ftnref2">2</a> <hr /> Practice Point: Many commentators (and even some insurance company documents) employ the expression “expected to last” [90 days], but curiously, the source material does not use this phrase. However, the intent is similar: “chronic illness” should be long-lasting, and long-term care policies should pay for care over the long-term. In this way, TQ policies were a break from the past, when these policies had no qualms about paying for short-term claims (i.e., less than 90 days). <hr /> To clarify, one’s elimination period states how soon after qualifying care begins that claim payments start, acting like a deductible. There is no conflict in saying, “As a tax-qualified policy, my plan will only pay for claims that last longer than 90 days, but I still want reimbursement from Day 1.” Nevertheless, since 1997 there’s been an explosion in the choice of 90-day elimination periods, which now make-up nearly 90 percent of the market. Having established an ADL trigger, the six activities of daily living are defined as: <blockquote>(1) eating; (2) toileting; (3) transferring; (4) bathing; (5) dressing; and (6) continence.</blockquote> In determining an individual’s inability to perform two or more ADL’s, a TQ policy must take into account at least five of these six. Much ink has been spilled debating the merits of “hands-on” assistance versus “stand-by” assistance. The former means the physical assistance of another person without which an individual would not be able to complete an ADL. Stand-by assistance is the presence of another individual necessary to prevent injury while performing an ADL (such as being ready to catch the individual if they fall while getting in the tub while bathing). However, HIPAA uses the umbrella term “substantial assistance”, which the IRS has subsequently clarified is either. The IRS also expanded its definition of the cognitive impairment (CI) trigger by advising taxpayers they could rely on a number of “safe harbor” provisions. These included a broadened definition of “severe cognitive impairment” as a loss or deterioration in intellectual capacity that is similar to Alzheimer’s disease and forms of irreversible dementia, and is measured by clinical evidence and standardized tests that reliably measure impairment in short term memory, long-term memory, orientation to people, places or time, and deductive or abstract reasoning. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 7702B(c)(1). <a href="#_ftnref2" name="_ftn2">2</a>. Notice 97-31, 1997-1 CB 417. </div>

March 13, 2024

478 / Can a life insurance policy or annuity contract be used to provide long-term care coverage?

<div class="Section1">Yes.<div class="Section1"> A life insurance or annuity contract may provide long-term care insurance benefits. Any long-term care insurance coverage, qualified or otherwise, that is provided by a rider or as part of a life insurance or annuity contract will be treated as a separate contract for purposes of the treatment of long-term care benefits paid.<a href="#_ftn1" name="_ftnref1">1</a> As such, benefits paid for qualified long-term care services are generally tax-free (regardless of the treatment otherwise applicable to a withdrawal from the underlying life or annuity contract) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="491">491</a>).<a href="#_ftn2" name="_ftnref2">2</a> <hr> Planning Point: By linking two distinctly fundamental needs, such products have earned the moniker “combination”, “hybrid”, “linked-benefit” or “asset-based long-term care”. There is no legal difference in these terms, which were instead born of marketing. (The IRS employs the term “combination contracts”.) <hr> There is no premium deduction permitted under IRC Section 213(a) for charges made against the cash surrender value of a life contract or cash value of an annuity contract which pay for qualified long-term care insurance (QLTCI).<a href="#_ftn3" name="_ftnref3">3</a> Rather, such charges serve to reduce the investment (i.e., cost basis) in the underlying contract by the amount of the charge—but not below zero. Since these charges are withdrawn from the policy’s cash value to pay for the QLTCI (albeit internally), they are considered “distributions”. Nevertheless, the amount of these charges is not included in gross income.<a href="#_ftn4" name="_ftnref4">4</a> <hr> Planning Point: In certain situations, a combination policy may be a modified endowment contract, or MEC. (Generally, most single-premium life combo products are MECs, i.e., they fail the seven-pay test.) When they were first established in 1988, MECs received less favorable income tax treatment than non-MECs: <ul> <li>Distributions (including withdrawals and loans) are received taxable gain first, tax-free principal last (LIFO), and</li> <li>Any distributions received prior to age 59½ are subject to a 10 percent penalty (unless taken for death, disability or as part of a life annuity).</li> </ul> <hr> The above MEC rules (LIFO tax treatment of distributions, and the 10 percent early withdrawal penalty) are the same treatment found in nonqualified deferred annuities. However, the Pension Protection Act (PPA) modified these rules effective January 1, 2010. Specifically, the PPA targeted distributions from life insurance (even MECs) and nonqualified annuities when used to pay for QLTCI: going forward, they would not be subject to immediate taxation or the early withdrawal penalty. Instead, these charges would simply reduce cost basis in the contract (but not below zero). To be clear, the linchpin of this favorable tax treatment is the requirement that the qualified long-term care coverage be made part of (or included as a rider on) the life or annuity contract from which cash value charges are made. None of the tax provisions cited above for combination life/long-term care or annuity/long-term care policies apply to any of the following:<a href="#_ftn5" name="_ftnref5">5</a> <blockquote>(1)     A tax-exempt (under a Section 501(a)) trust described in IRC Section 401(a) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3837">3837</a>)); (2)     A contract purchased by a tax-exempt (under a Section 501(a)) trust described in IRC Section 401(a)); (3)     A contract purchased as part of a plan under IRC Section 403(a); (4)     A contract described in IRC Section 403(b) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4027">4027</a>); (5)     A contract provided for employees of a life insurance company under IRC Section 818(a)(3); (6)     A contract from an IRA or individual retirement annuity ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3641">3641</a>); or (7)     A contract purchased by an employer for the benefit of an employee or an employee’s spouse.</blockquote> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 7702B(e)(1). <a href="#_ftnref2" name="_ftn2">2</a>.     IRC § 7702B(e)(1). <a href="#_ftnref3" name="_ftn3">3</a>.     IRC § 7702B(e)(3). <a href="#_ftnref4" name="_ftn4">4</a>.     IRC § 72(e)(11). <a href="#_ftnref5" name="_ftn5">5</a>.     IRC § 7702B(e)(4). </div></div>

March 13, 2024

480 / Do COBRA continuation coverage requirements apply to long-term care insurance?

<div class="Section1">No, they do not.<div class="Section1"> The COBRA continuation coverage requirements applicable to group health plans do not apply to plans under which substantially all of the coverage is for long-term care services.<a href="#_ftn1" name="_ftnref1">1</a> This provision is effective for contracts issued after 1996.<a href="#_ftn2" name="_ftnref2">2</a> A plan may use any reasonable method to determine whether substantially all of the coverage under the plan is for qualified long-term care services ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="356">356</a>).<a href="#_ftn3" name="_ftnref3">3</a> <hr> Planning Point: After a qualifying event at work (e.g. the employer’s failure to pay premiums), group health plans generally require that each qualified plan beneficiary be given the election to continue identical coverage. This is not the case with qualified long-term care insurance (QLTCI). <hr> As a practical matter, most QLTCI sold through the worksite, or sponsored by an employer, are individual policies. They are the exact same contracts sold on the retail market. However, by meeting certain participation thresholds, the insurer may extend premium discounts and underwriting concessions. But since they are individual policies, they are completely “portable” and not tied to employment in any meaningful way. There are some “true group” QLTCI plans—many of which have existed for some time, and some that are newly sold. These policies do operate under group regulations, where employees receive “certificates” (not policies), and an employee who works in Oregon, for example, might be covered by an Idaho policy form if that is where his employer’s “situs” is located. Although COBRA does not apply, one will find conversion privileges in group long-term care which, for instance, give certificate holders the right to continue making premium payments (and keep coverage in-force) in the event their employer discontinues the plan. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 4980B(g)(2). <a href="#_ftnref2" name="_ftn2">2</a>.     HIPAA ’96, § 321(f)(1). <a href="#_ftnref3" name="_ftn3">3</a>.     Treas. Reg. § 54.4980B-2, A-1(e). </div></div>

March 13, 2024

482 / How does the law treat long-term care contracts issued before 1997?

<div class="Section1">In short, these policies are called “grandfathered.”</div> <div class="Section1"> Any contract issued before January 1, 1997 that met the long-term care insurance requirements of the state in which it was issued is treated for tax purposes as a qualified long-term care insurance contract, and services provided under the contract or reimbursed by the contract will be treated as qualified long-term care services.<a href="#_ftn1" name="_ftnref1">1</a> <hr /> Planning Point: For many years, this was considered a major deal. Policyholders with “grandfathered” policies had the best of both worlds: the tax favorability of IRC Section 7702B, and the more liberal benefit triggers and policy language that preceded it. No one wanted to give that up, or do anything to forfeit it. Agents were extremely reluctant to replace any grandfathered plans (as they should be), except for the occasional few plans containing egregious policy language. <hr /> Planning Point: Although it’s much less of a question today (over 20 years later), there was some angst back in 1997 surrounding a policy’s “issue date”. After all, those issued prior to January 1, 1997 were “grandfathered”. But who chooses the “issue date”? It’s enough to know the IRS clarified it in Notice 97-31 as a date assigned by the company (no earlier than submission date, and sometimes coinciding with effective date). <hr /> By definition, certain policy changes are considered “material”, and others immaterial. Material changes require the exchange for, or issuance of, a new contract—one whose issue date cannot precede the date the changes take effect. Therefore, these changes will cause a loss of grandfathered status and are enumerated below: <blockquote>(1) a change in the terms of a contract that alters the amount or timing of an item payable by a policyholder or certificate holder, an insured, or the insurance company; (2) a substitution of the insured under an individual contract; or (3) a material change in contractual terms or in the plan under which the contract was issued relating to eligibility for membership in the group covered under a group contract.<a href="#_ftn2" name="_ftnref2">2</a></blockquote> Not everyone has found this guidance clear, so the carriers have given their own instructions for the kinds of changes that will cause a loss of TQ status, which generally include any increase in benefits (e.g., daily benefit, benefit period, elimination period or inflation protection). The following items are not treated as the issuance of a new contract: <blockquote>(1) a policyholder’s exercise of any right provided under the contract in effect on December 31, 1996, or a right required by applicable state law to be provided to the policyholder; (2) a change in premium payment mode; (3) a class-wide increase or decrease in premiums for a guaranteed renewable or noncancellable policy; (4) a premium reduction due to the purchase of a long-term care insurance contract by a family member of the policyholder; (5) a reduction in coverage requested by the policyholder; (6) a reduction in premiums as a result of extending to a policyholder a discount applicable to similar categories of individuals pursuant to a premium rate structure that was in effect on December 31, 1996, for an issuer’s pre-1997 long-term care insurance contracts of the same type; (7) the addition of alternative benefit forms that a policyholder may choose without a premium increase; (8) the addition of a rider to a pre-1997 long-term care insurance contract if the rider issued separately would be a qualified long-term care insurance contract under IRC Section 7702B and any regulations issued under this section; (9) the deletion of a rider or contract provision that prohibited coordination of benefits with Medicare; (10) the exercise of a continuation or a conversion right that is provided under a pre-1997 group contract and that, in accordance with the terms of the contract as in effect on December 31, 1996, provides for coverage under an individual contract following an individual’s ineligibility for continued coverage under the group contract; and (11) the substitution of one insurer for another insurer in an assumption reinsurance transaction.<a href="#_ftn3" name="_ftnref3">3</a></blockquote> Further, if a material change described in the regulations occurs to some certificates under a group policy but not to others, the insurance coverage under the changed certificates is treated as coverage under a newly-issued group contract, that is, a group contract that is no longer grandfathered, while the insurance coverage provided under the unchanged certificates continues to be treated as covered under the original grandfathered contract.<a href="#_ftn4" name="_ftnref4">4</a> The regulations provide examples of the correct application of the above rules, while also noting that taxpayers may not rely on Notice 97-31 with respect to changes made after 1998.<a href="#_ftn5" name="_ftnref5">5</a> (Due to the disruption and uncertainty that existed at the time, there were like-for-like exchange rights between non-TQ and TQ plans until January 1, 1998.) </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. HIPAA ’96 § 321(f)(2). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.7702B-2(b)(4). <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.7702B-2(b)(4). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.7702B-2(b)(3). <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. § 1.7702B-2(b)(5). </div>