Long-term care insurance can be expensive, particularly if purchased later in life. However, without long-term care insurance, many individuals who need home care or skilled nursing home care will watch their savings and assets dwindle as they pay for the high costs of that care. Federal tax laws encourage the purchase of insurance by permitting income tax deductions for premiums – however, the deductions are limited, and not all policies qualify for favorable tax treatment.
The First Condition: Limitations on Deductions
The Health Insurance Portability and Accountability Act of 1996, (HIPAA), changed the way that long-term care insurance premiums are taxed. The act changed federal tax laws so that long-term care insurance is treated the same as health and accident insurance under the federal tax code. As a result of this change, insurance benefits that reimburse individuals for care received may not be counted as taxable income to the insured. This change also means that premiums paid may be tax deductible depending on the insured’s total non-reimbursed medical expenditures during the year. This is the first condition for deductibility. Premiums paid for long-term care insurance are not eligible for a straight deduction. Individuals can deduct non-reimbursed medical expenses in excess of 10 percent of adjusted gross income, as of 2013. The total was 7.5 percent of your AGI until the 2012 tax year.
The Second Condition: Annual Limits on the Amount You May Deduct
Federal tax laws also limit the amount of long-term care premiums that may be added together with other non-reimbursed expenses to meet the threshold for deductions. The Internal Revenue Service issues a schedule of limitations upon premiums based on the age of the insured. These amounts are adjusted annually based on inflation. For tax year 2013, individuals age 40 or younger may deduct no more than $360 in long-term care policy premiums; age 41 through 50 may deduct no more than $680; age 51 through 60 may deduct no more than $1,360; age 61 through 70 may deduct no more than $3,640; and individuals older than 70 may deduct no more than $4,550.
The Third Condition: The Right Type of Policy
Not all long-term care insurance policies qualify for favorable tax treatment. The policy must be considered a tax-qualified policy. Benefits under tax-qualified policies are triggered when the insured person is no longer able to perform certain activities of daily living without substantial assistance, or when the insured person needs supervision because of dementia or other cognitive limitations. Tax-qualified policies are also required to include specific benefits including benefits that protect the insured person from having their policy canceled, or from accidentally letting their coverage lapse from failure to pay premiums. Policies must clearly state on the cover page whether they are tax-qualified.
Is It Worth It?
The tax deductibility of long-term care premiums is a benefit of purchasing long-term care insurance, but deductions are very limited and many people will not qualify for a deduction. However, that doesn’t mean that the coverage isn’t a good investment. The purchase of long-term care insurance is an important part of retirement planning and asset protection for many individuals.
Lynn Knauf has been involved in the insurance industry for more than 25 years working in a variety of positions including underwriting, claims and government affairs. She has written on insurance and political issues since 2010. Knauf holds a Chartered Property Casualty Underwriter designation.