TAX PERKS FOR NON-QUALIFIED ANNUITY OWNERS

You can thank the Pension Protection Act.

On January 1, 2010, owners of certain non-qualified annuities were allowed some new tax benefits. On that date, the Pension Protection Act (PPA) of 2006 was fully implemented and brought about dramatic and interesting changes for those who had started annuities with after-tax dollars.

**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.

 
New interest in hybrid annuities. Some variable annuities^# give you the option of buying a long term care insurance rider for additional cost. These are often called hybrid annuities or annuity/LTCI plans. Typically, the people most interested in them are annuity holders outside of their surrender period who have a need for long term care planning.

If it turns out that the hybrid annuity owner doesn’t need long term care, then he or she usually can choose from three options: arranging an ongoing income stream from the annuity contract, cashing out the annuity and paying income tax on the proceeds, or continuing to earn tax-deferred interest on the annuity.1

There are some trade-offs for the LTC coverage in these annuities. The cost of the LTC rider decreases the potential tax-deferred income stream resulting from the annuity contract. Benefits usually aren’t activated until two years after the annuity is purchased. Additionally, the LTC coverage only lasts for a certain number of years (though in some of these plans, the annuity owner may pay extra to extend it).1

The perk: tax-free withdrawals to pay for long term care. With all this in mind, owners of hybrid annuities can thank the PPA for this option.

These non-qualified deferred annuities with added long term care insurance riders are now characterized as tax-qualified LTC insurance plans.2

As a result, all withdrawals from these hybrid annuities are income tax-free so long as they are used for qualified long term care. So you can use the cash value of the annuity to cover the cost of LTC insurance premiums without triggering a taxable event.2

Annuity owners are now allowed to make tax-free 1035 exchanges into appropriate hybrid annuities with long term care riders.3

Additionally, an annuity owner can do a 1035 exchange for the cash value from any annuity into a single-premium qualified LTC insurance policy without incurring any gains.3

Now these annuities are even more attractive. Hybrid annuities with LTC insurance riders already offer their owners tax-deferred growth – and sometimes, a return of premium option that gives back the investment to an owner’s estate if no LTC claim is made. The allowance of what could be sizable tax-free withdrawals makes them look even better.

In addition, the freedom to make a tax-free exchange means that an annuity owner can now leave a current contract for a hybrid annuity that may provide a much greater pool of money someday to cover LTC costs. The possible downside: if you make that move before age 59.5, you may incur fees, charges and/or penalties as a result. (Keep in mind that annuity contracts are not **guaranteed by any federal agency; the **guarantee is a pledge from the insurer.)

Are they for you? These hybrid annuities are certainly worth a look. If you can’t qualify medically for LTC insurance but still need to be protected, a hybrid annuity may be an excellent option. Many people fund these annuities by redirecting cash from a bank CD or an annuity they already own. You might want to talk to a financial professional about the possibility.

These are the views of AnnuityGuys.com, which does not give tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent planner/educator professional. Please consult a financial advisor for further information.

Citations

1. registeredrep.com/newsletters/insuranceletter long_term_care_annuities_get_a_break_0915/ [9/15/09]
2. the complete lawyer.com/financial-matters/retirement-planning-financial-matters/new-laws-mean-important-changes-for-long-term-care-4333.html? nomobile [4/20/09]
3. financial-planning.com/bic_issues/2009_11/ the-new-wave-in-ltc-hybrids-2664417-1.html? ET=financia l planning