LTC Bullet:  Pension Protection Act of 2006 

Wednesday, February 7, 2007 

Austin, TX-- 

LTC Comment:  PPA '06 made some big changes in the tax treatment of annuity and LTC insurance products.  What does it mean?  After the ***news.*** 

*** 2008 BUSH BUDGET PROPOSAL for Health and Human Services http://www.whitehouse.gov/omb/budget/fy2008/hhs.html contains two provisions bearing on Medicaid LTC eligibility.  They're baby steps but at least they move in the right direction. 

"Refining Long-term Care Home Equity. With some exceptions, the Deficit Reduction Act of 2005 does not permit individuals who have more than $500,000 of home equity to be eligible for Medicaid long term care services. States have the option to increase the limit to $750,000. The Budget proposes to remove this option and maintain the home equity limit at $500,000. 

"Enhancing Asset Verification for Medicaid Eligibility. The President's Budget proposes to expand a Social Security Administration (SSA) pilot using electronic financial records for verifying an applicant's assets to appropriate HHS programs. State Medicaid agencies would be required to establish pilots in locations where SSA is operating such a pilot." *** 

*** NEED A WEBSITE?  All you have to do to have your very own LTC website designed by LTC Connection is to join the Center for Long-Term Care Reform.  That's right, join the Center for $150 per year, get all our publications and access to The Zone, including our new "Almanac of Long-Term Care," and on top of that LTC Connection will design your website and waive their usual $149 fee.  Or look at it this way, buy your website from LTC Connection through the Center and get a year of membership in the Center for only $1 more.  Sure, you'll have to pay LTC Connection's $39 per month website maintenance fee, but you'll get a whole year of LTC Bullets and LTC E-Alerts for no extra charge.  So, what do you have to do?  Just contact Damon at 206-283-7036 or damon@centerltc.com, join the Center, pay your membership fee, and say "I want my website."  We'll connect you with the right person at LTC Connection and you'll be on your way.  Great content from the Center and a great website from LTC Connection.  How can you beat it?  Already a member of the Center but want your free website?  No problem.  Renew your annual membership early and get the same deal. *** 

*** SEVENTH ANNUAL INTERCOMPANY LTCI CONFERENCE will be held at the Adam's Mark Hotel, in Dallas, TX from March 25-28, 2007.  Visit www.ILTCIConf.com for details and registration.  Known for its outstanding networking opportunities, this year's conference offers 20+ hours of exhibit networking.  Ten educational tracks led by top LTC specialists plus leading business.  Financial professionals from outside the industry will share their expertise and insights.  Opening the conference is the Distributors Roundtable.  And closing the conference, the popular CEO Forum is back.   I'll be there presenting the blockbuster findings from the Center's latest LTC study in Texas. *** 

 

LTC BULLET:  PENSION PROTECTION ACT OF 2006 

LTC Comment:  Ever since I met with then-Treasury official Mark Warshawsky in the Fall of 2005, I've been a believer in the potential to meld annuities and LTC coverage more effectively.  Warshawsky advocated improving the tax treatment of policies that combine the benefits of both financial products.  I added that arrow to my quiver of recommendations as I conducted Hill briefings on how to relieve the fiscal burden on Medicaid by encouraging private financing alternatives for LTC. 

We didn't get the needed changes in the Deficit Reduction Act.  But they came soon after in the Pension Protection Act of 2006, enacted August 17, 2006.  For a copy of PPA '06 and other information, see http://www.dol.gov/EBSA/pensionreform.html

Ever since this new law was enacted, I've been waiting to find some good analysis of its provisions.  For example:  what exactly do they mean?  Who's most likely to be affected?  What effect will the law have on the marketability of long-term care coverage?  Is there hope that it will help to wake people up to the need to plan for long-term care?  Will it relieve the fiscal burden on Medicaid? 

I'm still waiting for this kind of comprehensive analysis of PPA '06.  But in the meantime, a very interesting analysis of one aspect of the law's impact was brought to my attention by Center member Sally Leimbach of Franklin Morris in Baltimore. 

The source is Michael E. Kitces, MSFS, MTAX, CFP, CLU, ChFC, RHU, REBC, CASL, Director of Financial Planning, Pinnacle Advisory Group, Columbia, Maryland 410-995-6630, www.pinnacleadvisory.com, email: michael@kitces.com.  His analysis follows with permission: 

"Here's how people THINK [the Pension Protection Act of 2006] works. You put $100,000 into a new 2010 hybrid annuity-LTC product. The annuity earns $5,000 in growth, raising the cash value to $105,000. The annuity company subtracts $5,000 of funds from the annuity to cover the cost of LTC coverage, reducing the cash value back to $100,000 (this cost is just for illustrative purposes; I realize it's probably high for most people). Thus, the individual spent $5,000 of growth on LTC coverage and the contract is still worth $100,000 with a $100,000 cost basis. Thus, the owner got to use $5,000 of annuity growth tax-free, avoiding all the taxes that would otherwise have been paid on growth because the contract now has a value equal to its cost basis. At a 30% marginal tax rate, that's $1,500 of tax savings. Hooray! 

"Here's how it ACTUALLY works. You put $100,000 into a new 2010 hybrid annuity-LTC product. The annuity earns $5,000 in growth, raising the cash value to $105,000. The annuity company subtracts $5,000 of funds from the annuity to cover the cost of LTC coverage, reducing the cash value back to $100,000. HOWEVER, for tax purposes the $5,000 of LTC costs ALSO reduces the investment in the contract (i.e., cost basis) by $5,000. Thus, the individual actually finishes with an annuity worth $100,000, and a cost basis down to $95,000, which means the individual STILL has the full $5,000 of gains and will still owe every dollar of taxes due on that growth. All the individual actually did was spend his own after-tax cost-basis dollars on the LTC coverage. 

"The latter scenario is significantly less favorable than the former. In fact, the latter scenario, which is how the law REALLY works, is actually less favorable than NOT using a hybrid policy in many cases. In the real scenario, the individual is GUARANTEED to spend absolutely ZERO pre-tax dollars on the LTC coverage, because it must be subtracted from (i.e., use) after-tax cost basis dollars! In this case, the individual would have been better off putting only $95,000 into the annuity in the first place, and writing a check out of pocket for the $5,000 of LTC coverage; in that case, the individual at least MIGHT have been able to get a partial tax deduction as a medical expense deduction (to the extent expenses exceed 7.5% of AGI, and subject to the applicable age/dollar-limit chart). Even if the individual cannot get any medical expense deduction, at the extreme that means they're only EVEN with the real scenario above; the real scenario still never comes out ahead! (There is a slight exception to this if the cost basis has literally been reduced to $0, but I would anticipate that will be very rare in practice)." 

Here's how I replied to Mr. Kitces's message: 

Michael:  So, are you saying there is no benefit to the annuity/LTCi changes in the Pension Reform Act?  Steve 

Michael Kitces replied: 

"It might be an overstatement to say there's 'no benefit', but I certainly see very, very little benefit in almost all situations, at least with respect to the creation/purchase of hybrid annuity/LTCi and life/LTCi policies. I DO FIND A LOT OF APPARENT VALUE IN THE NEW PENSION PROTECTION ACT RULES ALLOWING FOR 1035 EXCHANGES FROM LIFE AND ANNUITY POLICIES INTO (OSTENSIBLY SINGLE-PREMIUM) LTCI POLICIES.  [Emphasis added.] 

"My gut tells me that the way the hybrid policies were drafted wasn't entirely intentional - I can't believe that Congress would have done it this way with a full understanding of the practical effect. I suspect that this was either a pure accident of drafting, or that the cost basis adjustment was added as a way to control the cost without an understanding of the associated ramifications on the value of the whole provision." 

LTC Comment:  We asked Bruce Moon of OneAmerica, a company that markets annuity/LTC products for his opinion.  He said that although it's true that taxes will be paid on remaining cash values from annuity/LTC products, there is still an important advantage, i.e. that taxes are not owed on qualified LTC expenses.  Any taxes on remaining cash values would be paid by the heirs, if there is anything remaining after long-term care expenditures are paid. 

We welcome further comments on the PPA '06 but would particularly like to receive a thoughtful, comprehensive analysis of less than 1000 words for publication as an LTC Bullet.  Any takers?