When people consider the subject of long-term care, they generally think about nursing homes. In fact, long-term care often has little to do with nursing homes. Much of the long-term care in this country is “custodial care” delivered in the patient’s home and not in a nursing facility. An understanding of that fact, the system for paying for long-term care, and the tax consequences can help practitioners better advise the families of the growing number of people who will need long-term care.
Improvements in health care and increases in longevity have led to an increase in the number of people who will need long-term care at some point in their lives. Thirty years ago, few people had ever heard of Alzheimer’s; today, it is a leading reason why people need long-term care services. The longer people live, the more likely they are to need care. The question is, what will providing that care do to their families and finances?
Long-Term Care Is Usually Custodial Care
Long-term care is defined in the Code as “necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services” for a chronically ill individual (Sec. 7702B(c)(1)). A chronically ill individual is someone who needs assistance with the activities of daily living (toileting, bathing, dressing, eating, transportation from one point to another, and continence) (Sec. 7702B(c)(2)). Chronic illness also includes cognitive impairment so severe that the individual needs constant supervision.
In today’s society, if a patient needs custodial care, chances are it will be delivered in the community, not in a nursing home. While the New England Journal of Medicine found that 43% of those over age 65 will need nursing home care, this was the percentage that may spend some time in a facility, not those who will permanently reside in one (Kemper and Murtaugh, “Lifetime Use of Nursing Home Care,” 324 New England Journal of Medicine, No. 9 (1991): 595). Every study conducted finds that care is overwhelmingly provided at home. The key question, of course, is who is going to pay for that care?
Who Covers the Cost?
Medicare does not cover the cost of long-term care. Although it is the primary health care program for retirees, it pays only for skilled or rehabilitative care, not custodial care in any venue (42 USC §1395d). Medicaid, a federal and state program for financially needy individuals, will pay for custodial care, but primarily in nursing homes (42 USC §1396a; 42 CFR §§409.33(a)(1) and (d)). Medicaid funding for home care and assisted living is very limited and is based on the availability of funds.
Many veterans believe that the Veterans Administration will pay for home care, adult day care, or assisted living. As with Medicaid, funding is limited and is generally based on service-related disability (see www.va.gov/healtheligibility/coveredservices/standardbenefits.asp). The federal government has in effect acknowledged this by encouraging veterans to purchase long-term care insurance through the new Federal Long-Term Care Insurance program.
The result is that consumers are forced to pay privately for their care. Unfortunately, the best thought-out retirement plan rarely takes into consideration all the ramifications of living a long life. Put another way, those assets and income have been allocated to pay for retirement, not for the consequences of living a long life. Chronic illness therefore results in the need to invade principal and divert income. As a result, one of seniors’ greatest fears—that of outliving their assets—may come true.
The Role of Long-Term Care Insurance
The use of long-term care insurance (LTCI) thus becomes an important part of planning for the increased risk of disability that comes from living a long life. The product has two roles: helping relieve families of the burden of caring for their disabled family member and allowing the family member’s retirement portfolio to serve the purpose for which it was intended—namely, retirement.
LTCI does not replace the need for family involvement in providing care but rather supplements it. It pays professionals to assist the affected person with the toughest tasks, such as toileting, bathing, and feeding. This in turn allows the family to provide longer and better care at home.
From a financial point of view, LTCI allows the patient’s retirement plan to stay intact. That is particularly important given the recent steep declines in portfolio values. LTCI in effect protects the balance of the account value. It also protects income. Although the patient may qualify for Medicaid to pay for nursing home costs by spending down (i.e., transferring) assets, his or her income (pension, Social Security, IRA, and 401(k) payouts) cannot be protected that way.
Tax Savings for LTCI
Individuals: Premiums paid for qualified LTCI are deductible as medical expenses on Schedule A, Itemized Deductions, but the deductible amount of the premiums is limited by the age of the individual at the close of the tax year (Sec. 213(d)(10)). The deductible portion of the premiums is inflation adjusted every year. For 2008, the deductible amounts are (Rev. Proc. 2007-66):
Age 40 or less $1,310
Age 41–50 $1,580
Age 51–60 $1,150
Age 61–70 $3,080
Age 71 or older $3,850
Self-employed individuals: Under Sec. 7702B(b), a self-employed person may deduct 100% of premiums paid for the individual, as well as the individual’s spouse and dependents, up to the maximum eligible allowed (as indicated in the above chart) without regard to the 7.5% medical expense limitation. The premiums are deductible as an above-the-line deduction on line 29 of Form 1040, U.S. Individual Income Tax Return.
Limited liability companies, partnerships, and S corporation 2% owners: These entity business owners are all treated as if they are partners. LTCI premiums have been classified as health insurance under Sec. 7702B(a)(3), and when the business pays the premiums, they are deductible by the business entity and are includible in the business owner’s income as guaranteed payments. The business owner can deduct the payments as self-employed health insurance to the extent allowable under Sec. 162(l) (Secs. 707(c), 162, 61).
C corporations, professional corpo rations, and tax-exempt organizations: These businesses may deduct, as a business expense, all qualified LTCI premiums paid for employees, employees’ spouses, and dependents, as well as retirees and their spouses. This includes the business owner, who is considered an employee of the corporation. The employer’s contributions toward the cost of the premiums are not included as imputed income to the employee (Secs. 162(1), 106).
Contributory arrangements: When the employer and the employee share the cost of the LTCI premium, the company may deduct all premiums it contributes for qualified LTCI plans as a business expense. Premiums paid for the spouse and dependents of employees and retirees and their spouses are treated similarly. For federal income tax purposes, the employee’s portion of the premium is treated as if paid by the individual and is deductible—subject to the age-based limits for individual taxpayers—to the extent the employee’s total unreimbursed medical expenses, including qualified LTCI premiums, exceed 7.5% of the employee’s adjusted gross income (Sec. 213(a)).
Per diem contracts: For 2008, the tax-free receipt of benefits under a per diem policy is limited to $270 per day. If the total of the benefits received for a period under a per diem policy exceeds this amount, the excess will be included in gross income (Sec. 7702B(d); Rev. Proc. 2007-66).
How Benefits Are Paid: Reimbursement Versus Indemnity
There are two ways that benefits are paid from an LTCI contract: indemnity or reimbursement. Under an indemnity provision, the insurance provider pays the entire daily/monthly benefit at the end of each month, no matter what the actual expenses were. This is an optional benefit/rider with some companies. The premiums for indemnity contracts are generally much higher than for a reimbursement contract, and these contracts and riders are getting harder to find.
Under a reimbursement provision, the policy will reimburse based on actual long-term care expenses incurred. The actual amount is subject to a daily/monthly benefit limit. Reimbursement can work in two ways:
1. The insured can pay the long-term care expenses and be reimbursed at the end of each month by the insurance provider.
2. The insurance provider can be billed directly by the care provider and the insured will be responsible for any expenses over the daily/monthly limit.
LTCI State Partnership Programs
Some states and private insurance companies have developed long-term care insurance partnership programs to encourage the purchase of LTCI by people who otherwise might rely on Medicaid to pay for their long-term care. Under such programs, people who purchase qualifying LTCI policies can retain a specified amount of assets and still qualify for Medicaid, once they use up their insurance benefits (provided they meet all other Medicaid eligibility criteria). See the exhibit on this page for listings of the states currently participating in the partnership program and those that have partnership plans pending.
Partnership programs are designed for people with low to middle incomes; however, surveys show that most purchasers have substantial assets (Kassner, “Long-Term Care Insurance Partnership Programs,” AARP Public Policy Institute, 2006). Each state can have different program features, so practitioners should be sure to check with the state in which the insured resides.
Deficit Reduction Act of 2005
The Deficit Reduction Act of 2005, P.L. 109-171, further defined the partnership program by paving the way for the creation of a national partnership program. Among other changes, the act denies Medicaid nursing home coverage to people with home equity exceeding $500,000 (states can elect up to $750,000). It also changed the Medicaid “lookback” date to the date of the application instead of the date of transfer and the lookback time from three to five years.
One item further defined is dollar-for-dollar asset protection. Basically, if the LTCI policyholder exhausts the policy, Medicaid will exempt the value of the policy. In other words, for every dollar of protection, a dollar of assets is exempt from a Medicaid spend down.
Filial Responsibility Laws
Thirty states currently have filial responsibility laws on the books (Bulcroft, Van Leynseele, and Borgatta, “Filial Responsibility Laws: Issues and State Statutes,” 11 Research on Aging, No. 3 (1989): 374). Under a filial responsibility law, adult children can be made responsible for the financial support of indigent parents and, in some cases, medical and nursing home costs. In most states, actual enforcement of the law has occurred only when a parent has tried to give away assets in order to “spend down” to Medicaid eligibility. However, nursing homes do not have to actually invoke the law, they just have to threaten to invoke it.
Suppose a parent dies in a nursing home. She has been there for three years and has not had the resources to pay the facility for her care. The final bill comes to $126,000. What would most children do if they got a call from the nursing home telling them that their state has a filial responsibility law and demanding payment for the parent’s care? Most children will be glad to settle the bill for $75,000 to avoid getting taken to court for the full amount.
Given all the recent activity concerning state partnership programs, the Deficit Reduction Act of 2005, and filial responsibility laws, practitioners should be talking to their clients about LTCI.
When purchasing insurance, individuals should look for a long-term care insurance specialist and consider his or her training, educational credentials, and commitment to help solve long-term care needs. The key is whether the specialist emphasizes a plan or a product. If he or she focuses first on product and price rather than the plan, the client should consider getting another opinion.