Many people bought a life insurance policy years ago to protect a young family. Now the kids are grown, the mortgage is paid, and the bigger worry is what happens if they need long-term care. If that sounds familiar, you may be wondering whether you can turn that old life insurance policy into long-term care (LTC) coverage. In many cases you can, and it can be done without triggering taxes. Here is what to consider.
Why long-term care is worth planning for
Long-term care is expensive. A private room in a nursing home now costs around $10,800 a month on average nationally, and assisted living around $6,200 a month. Medicare covers very little long-term custodial care, and Medicaid generally pays only after most of your assets are gone. Without a plan, a few years of care can consume a large share of a lifetime of savings.
How the exchange works
Since 2010, the tax code has allowed you to exchange a life insurance policy or an annuity for a qualified long-term care insurance policy as a tax-free “1035 exchange,” named for the section of the Internal Revenue Code that permits it. Without this rule, cashing in a life insurance policy with a gain would be taxable. With it, the cash value moves directly into the new LTC policy without current tax.
A few important details:
- The money must be transferred directly from the old policy to the new one. If the cash is paid to you first, it is not a tax-free exchange.
- The new policy must be a tax-qualified long-term care policy.
- Not every insurance company accepts 1035 exchanges into LTC coverage, so your options may be limited.
- You still have to qualify for the new coverage medically, and premiums depend on your age and health.
Another option is a hybrid policy that combines life insurance with long-term care benefits. These can also be funded with a 1035 exchange, and if you never need care, they still pay a death benefit to your heirs.
Questions to ask before you exchange
- What would you be giving up? Review the death benefit, premiums, and cash value of your current policy. If your family still depends on that death benefit, or you want to leave a legacy, surrendering it may not make sense.
- Can you qualify? Your age and health determine whether you can get LTC coverage and at what cost. It is usually best to apply for the new coverage before giving up the old policy.
- How much coverage do you need? Consider your family history, where you would want to receive care, the cost of care in your area, and whether family members could help.
- How does it fit your overall plan? Look at your retirement savings, other insurance, and other ways you could pay for care, such as self-funding from investments.
The benefits of long-term care coverage
- Protecting your assets. Insurance can keep the cost of care from draining the savings you planned to live on or leave to your family.
- Choice. Coverage can give you more say in whether you receive care at home, in assisted living, or in a nursing home.
- Relief for your family. Having a plan in place lets family members focus on supporting you rather than worrying about how to pay for care. I learned this firsthand, as I wrote in 5 Things I Wish I Told My Dad.
Insurance guarantees are based on the claims-paying ability of the issuing company, and policy availability and costs vary by state. Before exchanging any policy, review your options with a financial advisor and a licensed insurance professional who can compare the costs and benefits for your situation.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
