22 Jun Long-Term Care Taxes
Is Long-Term Care Insurance Tax-Deductible?
No one enjoys thinking about long-term care insurance. After all, the idea that you may someday need assistance carrying out everyday tasks — like getting dressed, preparing and eating food, and showering or bathing — is far from pleasant. However, it’s important that everyone take the proper care to plan ahead for this possibility by purchasing long-term care insurance.
Long-term care coverage pays benefits to cover caring for a chronic or debilitating medical issue, like dementia. This policy provides coverage to help you pay for home health assistance, an apartment in an assisted-living facility, a nursing home bed, or a spot in an adult daycare facility.
Understandably, people have many common questions about long-term care insurance. One of the most common is whether the money you spend on this coverage is tax-deductible. Let’s take a look at how long-term care insurance works and determine whether you’ll be able to deduct your premiums from your annual taxes.
What Is Long-Term Care Insurance?
As with any form of insurance, you need to purchase long-term care insurance before you need it. The problem? Many people can’t fathom the idea that they would ever need to live in an assisted-living facility or require home health care. However, once you reach middle age, it’s something that you should at least consider.
The typical age to buy long-term care insurance is from 55 to 65. For the most part, it’s usually unnecessary to purchase this form of coverage much earlier than that. After all, the odds that you develop a debilitating condition that requires long-term care insurance in your 30s or 40s is rare (but certainly far from impossible).
However, a quick look at statistics makes many people realize how important long-term care coverage can be. If you live to reach the age of 65, there is a roughly 50% chance that you will require long-term care services due to a disability at some point in your life.
It’s crucial to understand that your standard health insurance policy will provide no assistance with long-term care. Meanwhile, Medicare can provide only a small drop in the bucket by covering brief spurts of assisted-living or home health care for rehabilitation purposes after an injury or illness. However, Medicare provides no assistance for basic daily care, such as eating, bathing, etc. If you have a low income, you might qualify for Medicaid, but this is strictly a last resort, and it covers only the bare minimum of care standards.
Another important aspect is how much long-term care costs without insurance. Home health care and assisted-living facilities typically cost somewhere in the ballpark of $50,000 per year, while a private room in a nursing home can easily exceed $100,000 annually. Even a spot in an adult day care program can cost around $20,000 per year. Obviously, if there’s a 50% chance that you’ll end up needing any of these services — even if only briefly — it could destroy your savings if you don’t have long-term care insurance.
How Does Long-Term Care Insurance Work?
The details of each policy can vary. For the most part, you will likely begin the process of applying for long-term care insurance by filling out an application, providing medical records, and participating in an interview. Once you’ve chosen the coverage limits for your policy and the insurer approves you, you can start paying your premiums (and receiving benefits).
When do you qualify for long-term care insurance benefits? Again, there’s some potential variance in this area, but most policies specify that you must be unable to perform two of the six activities that are defined as “crucial for daily living.” These activities include getting out of bed, using the restroom, bathing, dressing, eating, and incontinence care. You can also usually qualify for benefits if you have a serious mental impairment, such as Alzheimer’s or dementia.
However, before you receive any benefits, you need to get past the elimination period. This is a predetermined period (typically three months or less) in which you need to pay for your own long-term care services before your insurance policy kicks in.
How Much Does Long-Term Care Insurance Cost?
Insurance companies use many variables to determine the pricing for each long-term care insurance policy. Among them are your age, health, marital status, gender, coverage amounts, and which insurance company you purchase your policy from. Therefore, the costs of these policies vary widely depending on who buys them.
To illustrate a quick example, let’s assume that you’re a 60-year-old unmarried man with no significant health issues buying a long-term care plan. For this individual, premiums would likely cost roughly $2,000 per year for benefits capped around $175,000. However, in a typical long-term care insurance policy, your benefit limits increase each year, as your policy gains interest. If your benefits compound each year at a rate of around 3%, you could be eligible for about $400,000 in benefits by the time you hit your 85th birthday.
This is only an example, and your premiums may not remain consistent throughout the life of your policy. With many long-term care coverage plans, your premium rates are not guaranteed. Because the government wants insurance companies to remain profitable enough to pay legitimate claims, it will sometimes allow insurers to increase rates to cover higher-than-expected claim amounts.
Where Can You Buy Long-Term Care Insurance Coverage?
Interestingly, in the last 25 years, the number of insurers who offer these policies has bottomed were once in excess of 100 companies selling long-term care insurance to Americans. However, today, there are only about ten insurance firms in the entire country that still sell this form of coverage were once in excess of 100 companies selling long-term care insurance to Americans. However, today, there are only about ten insurance firms in the entire country that still sell this form of coverage.
The biggest issues are fairly simple to understand. First off, there is a ton of uncertainty involved with long-term care insurance. When an insurer sells a policy, they don’t have the slightest clue whether they’ll end up paying the maximum amount of benefits allowed under the policy or nothing at all. While uncertainty is part of any insurance policy, it’s unquestionably fair to say that long-term care coverage incorporates more uncertainty than life insurance or even standard health coverage.
The other side of this coin involves the profitability of the insurance market in general. Insurance companies make money by investing your premium payments in a way that returns more money than they pay out. However, interest rates remain very low, limiting the potential profits for an insurer. When you factor in the high degree of uncertainty that’s baked into a long-term care insurance plan, it’s easy to see why so many insurance providers have exited the long-term care marketplace.
How Are Long-Term Care Insurance Premiums Taxed?
It’s hard to paint long-term care insurance taxation with a broad stroke because there are quite a few variables that can affect the taxes you’ll need to pay. However, for the most part, part of your annual premium can be deducted from your taxes. This is because the Internal Revenue Service (IRS) allows Americans to deduct all medical expenses that encompass at least 10% of their annual adjusted gross income (AGI).
For those of you over the age of 65, that figure drops to just 7.5%. Meanwhile, if you are self-employed, a freelancer, or a contractor, you can deduct your qualified long-term care coverage premium as long as you turned a profit in your most recent tax year. For these workers, there is no threshold ratio that must be met before they can start deducting expenses.
That said, there is an upper limit to how much insurance premium you can deduct in any given year. These limits are tied to your age at the end of each year you hold the policy. If your premiums exceed these limits, you are not allowed to deduct the remaining portion as a qualified medical expense on your taxes.
For people 40 and under, the government will allow you to deduct just $450 of long-term care premiums. If you’re between 41 and 50, that number jumps to $850. For those of you between the ages of 51 and 60, you can deduct $1,690. Meanwhile, people from 61 to 70 can deduct up to $4,520, while policyholders 71 and older are allowed to bump that number up to $5,640. The IRS just increased these limits for 2021. Previously, some of these limits were considerably lower — for people in their 70s, the allowable deduction increased by more than $200 between 2020 and 2021.
It’s also important to note that these guidelines only cover federal regulations. Depending on your state, the tax codes could have different triggers and limits for deductions. For more information, check with your insurance agent or contact your state’s taxation or revenue department.
What Is a Qualified Long-Term Care Policy?
You may have noticed the use of the word “qualified” in the previous section. This term refers to a policy’s eligibility for a tax deduction. The requirements for a qualified long-term care insurance plan are set by the National Association of Insurance Commissioners. There can be quite a bit of legalese and nuance involved, so let’s break this down in a relatively simple manner.
Much of the conversation around qualified policies centers on triggers. In this context, a trigger is a medical condition that kicks the policy into gear. To be qualified, a long-term care insurance plan needs to offer its policyholder triggers for cognitive decline and daily living activities. The trigger for daily living activities in this regard is the same as the condition for receiving benefits: you must require help with a minimum of two daily living activities. There is an additional qualifier for daily living activities as well. A physician or a nurse needs to confirm that you will need help with these activities for a minimum of three months.
As for cognitive decline issues, the guidelines are considerably vaguer, and for good reason. Cognitive issues are difficult to quantify. Therefore, the trigger for cognitive decline kicks in when a medical professional certifies that you need “substantial” assistance to function in a manner that poses no threats to your own well-being.
How Are Long-Term Care Insurance Benefits Taxed?
We’ve covered how deductions work for long-term care insurance premiums. But are there taxation responsibilities involved with receiving benefits from these policies? For the most part, you won’t need to worry about paying taxes on your benefits. The IRS does not consider these payments to be income.
The one common exception is if your long-term care policy includes a per diem. If it does, you may need to pay taxes on any benefits that exceed $400 per day. In addition, you could be required to pay taxes on benefits that exceed your actual long-term care costs. However, this isn’t a concern for most people, as a typical long-term care insurance policy will cap benefits before they exceed expenses.
The question of whether long-term care insurance premiums are tax-deductible is an interesting one, in part due to the expenses involved. Typically, independent insurance agents and financial advisors recommend that you spend less than 5% of your total income on long-term care premiums. Given that the threshold for deducting medical benefits is 10% of your income, even a robust long-term care insurance plan would only get you halfway there.
For people over 65, it’s considerably easier to reach this level, because the threshold for deductions drops to just 7.5%. When you consider that this limit includes all of your qualified medical expenses, it’s easy to see how it might not be too difficult to reach it in your retirement years. Still, many people don’t get to deduct any of their long-term care insurance premium costs.
Do you still have questions about the ways long-term care coverage can affect your taxation? Speak with an independent insurance agent or financial advisor to get the specifics for your situation and hear about the options available to you. Overall, long-term care insurance is a vital part of any aging person’s insurance portfolio, but you should shop around to make sure you find the best deal for your needs.