Your home: You love it, but sometimes you have to leave it.
Whether it's the eight hours a day or eight days on a dreamy beach, allowing your biggest investment to fend for itself can be stressful. And it's a legit concern; when your home looks empty, break-ins happen. A lot. Ugh.
You could deter burglars by never leaving your house again. Or you could do the next best (OK, way better) thing, and just make it look like someone is there all the time. Here's how.
#1 Light Up a Room (From the Road)
Your parents may still rely on their lighting timer — on at 8 p.m., off at 7 a.m. That old-fashioned option still works, but apps are more fun. They not only turn your lights on and off, but can do so randomly for a more realistic effect. And you can decide to flip on your porch light while sipping a mojito in Fiji.
#2 Fake a Netflix Binge
Nothing says "we are definitely home" like the colorful glare of a television dancing in the window.
Put the little FakeTV gizmo where it can project light onto a curtain, and that's exactly what your home will say to passersby.
The device (which runs between about $20 and $40 depending on size) plugs into an adapter and can either work on a timer or with a light sensor, so it can switch on when it gets dark.
#3 Change Up Your Shades Remotely
Leave your window shades down while you're gone and you might as well put out a "Gone Fishin'" sign.
Check out wireless options to throw some shade on the go. Several companies have systems — including Hunter Douglas PowerView, Pella Insynctive, and Lutron Serena — that allow shades to go up and down at your command for about $300 to $500 a window.
#4 Make Some Noise
Burglars can change plans in a hurry at the first sound of life inside a home — they're a bit tetchy that way. So one option when you're just gone for the day is a noise app, like Sleep And Noise Sounds that can play on a homebound phone, tablet, or computer. With noises like vacuuming and a boiling kettle, it can deter a thief who cracks open a window.
#5 Make Them Ring And Run
"Burglars will often ring your doorbell, and if no one answers, they'll go around back and kick in the door," says Deputy Michael Favata with the Monroe County Sheriff's office in New York. Now you can answer the door with the Ring Video Doorbell ($180 for the basic model).
If someone pushes the doorbell, you can talk to them through an app on your phone. Whether it's your nosey neighbor or a sketchy stranger, you can say, "I'm in the basement" while you're really on the slopes. They'll never know. And even if they don't believe you, they know they're being watched (insert devilish laugh here).
#6 Try a No-Tech Technique
Not everything requires a gadget. Here are ways to up your home security without downloading a single app:
Hire a house sitter. Then someone will be home.
If there's snow, have a neighbor walk up and down the path to your door, shovel a passage up to the garage door and drive in and out of the driveway. If it's hot out, ask them to keep your plants looking fresh with regular waterings. And don't forget to bring them a nice gift from your getaway.
Ask friends, family, or neighbors to just be present on your property — use your patio, play in your yard, or bring in the mail.
Invite a neighbor to keep a car parked in your driveway. During the holidays, they may be happy if they need overflow for visitors.
Install a fake security camera for as low as $8. Burglars may not notice these fakes don't have all the wiring necessary to be real. And their blinking red lights offer reasonable doubt.
Get a dog. A real dog. While you're at work or running errands, nothing deters bad guys and gals like a barking security guard. And when you go away, having a pet sitter stay can be as economical as some boarding facilities (especially if you have multiple dogs), and you'll get the benefit of a human and canine sentinel.
Although the financial burden associated with medical expenses can be alleviated through the utilization of Medicare and Medigap programs, they do not offer coverage for long-term ‘custodial care.’ Costs related to this type of service are usually very expensive and often result in a considerable depletion of an individual’s retirement funds.
Evaluations to Make Before Purchasing
LTC insurance provides important financial protection against the cost of long-term care for individuals who stand the chance of losing accumulated income or wealth in paying for such care. However, not all individuals need to purchase LTC coverage, especially those individuals who are eligible for financial assistance through Medicaid.
Determining whether not an LTC policy should be purchased, individuals should take the following into consideration:
- Health history
- Family assistance
- Cost of required care
- Savings and Assets that may be lost
Long-Term Care (LTC) Insurance provides coverage for expenses associated with custodial care and assisted living for individuals who have lost the ability to remain completely independent. LTC coverage provides care, usually for a period 90 days or more, and can be provided by an adult care center, nursing home or at an individual’s home. While some LTC policies offer unlimited lifetime coverage, most plans limit coverage periods from 3 to 5 years, often with limited benefit amounts.
Upon deciding to purchase LTC coverage, determining the conditions, benefits and cost of the policy are also important to evaluate, as well as any elimination periods, policy limitations, policy rate increases and the overall financial health of the LTC insurer.
Ways to Issue Contracts
Individual
LTC insurance can be purchased on an individual basis where the policy is paid for by the individual and provides coverage directly to the individual for whom the policy is written, or can be written as an endorsement (rider) to a life insurance policy. LTC premiums are determined by the age and medical history of the applicant. Generally speaking, the younger the individual, the lower the LTC premium required.
Group
LTC insurance can also be provided to members of a group. As with life and health insurance, a group LTC policy is issued to by the insurer to the sponsor of the group who serves as the master policyholder and issues certificates of LTC coverage for participating members of the group. Upon termination from the group, an individual must have the right to continue or convert to an individual LTC policy without requiring evidence of insurability.
LTC Benefit Payments
Long-term care insurance policies provide benefits through either fixed dollar amounts or expense-incurred amounts. LTC benefit payments are based on a per-day basis to cover the daily LTC expenses incurred by the insured individual.
Fixed Payments
As an example, if an insured’s fixed LTC indemnity payment is $150 per day, but the insured’s LTC costs are only $120 per day, the insurer still pays the insured the entire $150 daily benefit amount as long as LTC coverage is needed.
Expense-Incurred Payments
Some insurers now follow an expense-incurred basis that covers the actual charges that were incurred in comparison to a fixed dollar amount.
Long-term care provides coverage when physical or mental conditions, whether acute (such as pneumonia) or chronic (such as heart disease), impairs an individual’s ability to perform the basic activities of everyday life such as feeding, toileting, bathing, dressing and walking.
Types of Long-Term Care
Dependent on the severity of an individual’s medical needs, LTC coverage provides for various types of care, from around-the-clock physician’s care in a nursing home to basic living services performed by medically trained individuals in the patient’s home.
Skilled Nursing Care
Usually administered at nursing homes, this type of long-term care involves around-the-clock care by a licensed medical professional under the supervision of a certified physician.
Intermediate Nursing Care
Similar to skilled nursing care, ‘intermediate’ long-term care is also offered at nursing homes by registered nurses under the supervision of a physician, but without around-the-clock care.
Custodial Care
Although it must be given under a doctor’s order, this category does not require services to be performed by a medically trained individual. These services include bathing, dressing, getting out of bed and toileting, to name a few services. Long-term care assistance can be administered within a nursing home or adult day-care center; however, most long-term care is administered at the home of the patient, also known as ‘custodial,’ or residential care.
Qualified vs. Non-Qualified LTC Plans
Qualified LTC plans are federally qualified for tax benefits when such plans stipulate that covered individuals must be diagnosed as chronically ill, whether such illness is physical or cognitive, unless prior hospitalization occurred and the individual is considered acutely ill.
Chronic physical illness includes the inability of two or more of an individual’s daily activities for a period of at least 90 days, such as feeding, toileting, bathing dressing and mobility. In order to qualify as cognitively impaired (a deficiency in the ability to think or reason), an impairment diagnosis must be certified by a physician within the previous 12 months.
Non-qualified LTC plans do not require such diagnosis, nor any other specific requirement since it is not mandated under the federal tax code, unlike a qualified LTC plan. While such plans do not receive favorable tax treatment, individuals who do not qualify for a qualified LTC plan, based on the individual’s medical diagnosis, often do qualify for a non-qualified LTC plan.
Types of Contract Limits
Although there are numerous LTC plans available for those in need, similarities can be found throughout which enable us to discuss basic provisions and limitations found in many of these plans. As an outcome of the Health Insurance Portability and Accountability Act (HIPAA) of 1996, all long-term care plans must contain provisions that enable their benefits to qualify for tax-exempt treatment as well as adopting specific provisions of the NAIC’s long-term care insurance model regulation.
Elimination Periods
The elimination period in an LTC policy is often referred to as a ‘time deductible,’ and can range from zero to 365 days. Generally speaking, the longer the LTC’s elimination period, the lower the LTC’s premium, as well as, the longer the LTC’s benefit period, the higher the LTC’s premium.
Daily Benefit Limits
Whether fixed or expense-incurred, payments provided by an LTC policy are limited to a daily maximum. Expenses that exceed policy maximums are the responsibility of the insured. Determining the correct daily maximum benefit level is commonly based on the average LTC costs within the geographic area of the insured.
While most states mandate a minimum daily benefit amount, daily maximum levels coincide with the amount of premium paid by the policyholder.
Lifetime Maximum Limits
Also directly correlated with premium is the amount of time in which benefits are payable by the insurer. It is important to choose a policy that is both affordable and provides enough LTC coverage for what an individual might expect in the future. An insurance agent’s job is to help determine the correct amount of coverage based on his or her evaluation of the applicant.
Guaranteed Renewable and Non-Cancellable
As a requirement of HIPAA, as long as premiums are paid, all LTC plans must be guaranteed renewable and non-cancellable. An insurer cannot make any other changes to a LTC policy once it becomes effective.
The insurer has the right to increase premium rates on an LTC policy over time only if it increases the overall premium of a large group, or ‘class’ of individuals, but not on an individual basis.
Waiver of Premium
Most LTC policies include a waiver of premium provision that waives an individual’s need to pay premium while receiving LTC benefits. This option is usually effective once a patient has been under the care of a licensed physician for a period of at least 90 days of confinement.
Specified Exclusions
The following are almost always excluded from LTC policies: acts of war, self-inflicted injuries, and drug and alcohol dependency.
Skilled vs Non-Skilled Nursing Care
Skilled nursing care requires the care of a licensed nurse under the orders of a physician; whereas, non-skilled nursing care pertains more to the personal daily living assistance, known as the Activities of Daily Living (ADL) of a patient including bathing, feeding, administering medicine and general maintenance of the patient.
Long-Term Care Facilities
Home Health Care
Medically-necessary care conducted by a registered nurse is often performed within the home of the patient, in comparison to care within a hospital. This type of rehabilitative service is designed to help patients readjust to everyday living, commonly provided after a stay in the hospital. This type of in-home skilled nursing care provides both rehabilitation, as well as daily living assistance, if necessary.
Nursing Facilities – Adult Day Care and Assisted Living
Assisted living centers, also known as ‘nursing homes,’ are available for individuals who require substantial assistance in daily living activities and provide a variety of healthcare services, as well as a group living environment, versus seclusion for individuals who are ‘homebound,’ or have lost the ability to live alone. The difference between nursing facility care and skilled nursing care is dependent on the type and extent of care required by a patient.
Hospice Care and Respite Care
Considered an optional benefit of LTC, it provides for the control of pain and provides a comfort of living for terminally ill patients. Respite care allows for the temporary medical care of a dependent that allows for the primary caregiver, usually family member, to receive a short period of time ‘off’ from providing care, whether for a few hours per day or for a period of a few weeks. The dependent is either cared for within their residence or at a medical institution.
LTC Partnerships
Traditional LTC vs. Partnership Policy
Both traditional policies and Partnership policies provide long-term care coverage; however, in comparison to a traditional LTC policy, a Partnership policy is more highly regulated by the state, it provides a tax deduction to consumers and it includes an additional benefit known as ‘Medicaid Asset Protection.’
Medicaid Asset Protection
To qualify for Medicaid, an individual’s income and personal assets determine his or her eligibility. Low or no income individuals who cannot afford to cover long-term care costs after LTC coverage has been exhausted typically qualify for Medicaid; however, since eligibility is also based on an individual’s personal assets, in cases where an individual’s assets exceed state Medicaid eligibility levels, such assets prohibit the individual from Medicaid eligibility. As a result, in order to qualify for coverage, an individual would need to sell off his or her assets in an attempt to ‘spend down’ to a level low enough to qualify for Medicaid.
However, through Medicaid Asset Protection in a Partnership policy, an individual can disregard, or will not have to ‘spend down,’ his or her personal assets. As an added benefit of a Partnership policy, and at no additional cost, Medicaid Asset Protection provides financial protection against personal asset loss in the event that an individual, based on insufficient income, needs to apply to Medicaid for long-term care coverage after he or she has exhausted private coverage. Referred to as Asset Disregard, Medicaid eligibility is adjusted for enrollees in a Partnership policy, disregarding personal assets in determining Medicaid eligibility. Medicaid Asset Protection is a benefit of a Partnership policy, but is not included in a traditional long-term care policy.
It is important to note that although the personal assets of a Medicaid applicant are disregarded, income from social security, interest income and income from a pension are not protected from Medicaid eligibility rules and can determine Medicaid eligibility. Assets that are disregarded under a Partnership policy include items such as cash, savings and checking accounts, stocks and bonds, certificates of deposit, money market certificates, IRAs and real property. Under Medicaid Asset Protection, these same personal assets are protected from Medicaid ‘estate recovery.’
Both the federal and state governments mandate Medicaid Estate Recovery in which the state reimburses itself for the costs it incurs by a Medicaid recipient through the recovery of the recipient’s personal assets and savings. States mandate such recovery of costs for all individuals age 55 and older who receive Medicaid benefits such as nursing facility services, home and community-based services, and related hospital and prescription drug services.
Estate recovery includes the state’s taking possession of a Medicaid recipient’s personal assets, excluding the proceeds of a life insurance policy or annuity contract, or the recipient’s personal effects and family keepsakes. Recovery of an individual’s estate after his or her death is also common unless such recovery creates an undue hardship for the recipient’s surviving spouse, dependent children under the age of 21, or disabled or blind dependent children of any age.
Again, in addition to ‘asset disregard’ in determining Medicaid eligibility, Medicaid Asset Protection also prohibits the recovery of a Medicaid recipient’s estate up to an amount at least equal to the amount of benefits used through the Partnership policy. It is important to note again that an individual’s income from social security, interest income and income from a pension are not covered by Medicaid Asset Protection and, if eligible for Medicaid, this income would ultimately be used to reimburse the state for the cost of the Medicaid recipient long-term healthcare.
Types of Asset Protection
The amount of Medicaid Asset Protection provided to an enrollee is based on the type of protection he or she qualifies for upon initially purchasing a Partnership policy. Two types of asset protection are available: ‘dollar-for-dollar’ and ‘total asset’ protection. The type of asset protection depends on the amount of coverage initially purchased compared to the State-Set Dollar Amount, which is the minimum initial amount of coverage an applicant must purchase in a Partnership policy in order to earn ‘total’ asset protection.
An applicant who initially purchases a Partnership policy with less than the state-set dollar amount in benefits is provided with an equal amount of asset protection for each dollar of Partnership policy benefits paid out, but does not receive total asset protection. In comparison, an applicant who initially purchases a Partnership policy with at least the state-set dollar amount and whose policy includes at least a 5% ‘compound inflation factor,’ is provided with total asset protection once the Partnership policy has been exhausted. The compound inflation factor requires benefits that are mandated by the state to increase annually by 5% or at the inflation rate associated with the consumer price index to keep up with the rising cost of healthcare
A Total Asset policy protects all assets if an individual needs to apply for Medicaid after exhausting all Partnership LTC coverage. Under total asset protection, all assets (not income), are protected from Medicaid spend down and estate recovery. In comparison, a Dollar-for-Dollar policy provides asset protection equal to the amount paid out in benefits from the Partnership policy, up to the policy’s benefit limit.
National Reciprocity Compact
The National Reciprocity Compact allows participating states to opt in and out of their reciprocity agreement at any time within 60 days’ notice. If a state opts out of reciprocity, individuals who have already accessed Medicaid continue to qualify for coverage. If a state’s Partnership program ceases to exist in the future, a resident who purchased a Partnership policy prior to such date would still be eligible to receive earned asset protection under the state’s Medicaid program.
Asset protection under a reciprocity agreement with another state is on a dollar for dollar basis. In order to receive total asset protection, an individual would need to move back to the state in which he or she purchased a Partnership policy.
An Annuity is a financial vehicle that provides income at a future date in an individual’s life and is commonly used to save up for higher education costs or as a retirement savings fund. An annuity is considered to be a form of insurance that provides future income to an individual while still alive, instead of when he or she dies. As a financial product offered by financial institutions and insurance companies, money is deposited either as a lump sum or as a series of payments by the owner of the annuity to a financial institution which then invests the money, tax-deferred, in order to earn interest and accumulate value for the investment.
Later in the annuity owner’s life, payments are distributed back from the financial institution along with the investment’s earned interest. An insurance company is able to offer annuities because of its ability to guarantee annuity payments for the entirety of the annuitant’s life, regardless of the age of the individual.
4 Parties Involved in an Annuity
- Insurance company (or other financial institution)
- Owner of the annuity
- Annuitant
- Beneficiary
- Annuity Structure and Design
An annuity is a legally binding contract involving an insurance company (or other financial institution), the owner of the annuity, an annuitant, and the annuity’s beneficiary. Although the owner of the annuity contract is often the same individual as the annuitant, both roles are unique to the contract.
The annuity’s owner is responsible for depositing funds in the form of premium payments into the annuity as well as for all taxes owed from the annuity’s earned interest. In return, the insurer invests the owner’s premium payments in stocks, bonds or securities, depending on whether the annuity is ‘fixed’ or ‘variable,’ and over time the annuity builds value.
When the annuity matures it ‘annuitizes,’ meaning that the contract begins to distribute both the Invested Principal and Earned Interest to the annuitant to serve as future income. If the annuitant dies before the contract is annuitized, the contract’s beneficiary becomes the receiver of the contract’s payout.
Both the owner and insurer benefit from an annuity contract because both parties earn interest on the invested payments by the owner.
During the annuity’s growth period, known as the Accumulation Period, interest that is earned by the investment is ‘compounded,’ or reinvested on a tax-deferred basis, thus allowing for a greater accumulation of funds for the annuitant. By compounding the interest, each year’s returns are re-invested, thus providing the annuitant with an exponential growth rate.
Once the contract annuitizes, a second period, called the Annuity Period, or ‘payout’ period, begins. During this period, the interest that accumulates is taxed appropriately as ‘gains,’ or earnings, on the investment; however, since the invested funds paid into the annuity using after-tax dollars, only the earned interest, or gains, on the investment are taxed,
The invested funds and earned interest can be distributed back to the annuitant in a variety of ways such as over a certain period of time, at a specific monetary amount per payment, or it can even serve as a death benefit to an annuitant’s designated beneficiary.
Group vs. Individual Annuities
Similar to an individual annuity, a group annuity provides monthly income to members of the group. Each member of the group is provided with a certificate that defines his or her participation rights in the group annuity.
A group annuity is often purchased to fund ‘defined benefit’ pension plans in which an employer establishes to provide future pension to company employees. Likewise, individuals purchase annuities to provide a structured future stream of income.
Business and Personal Uses of Annuities
Business Uses
Often set up by employers as part of a retirement compensation package, a qualified annuity is often used to fund pension plans, 401(k) plans, 403(b) plans, SEPs, and other retirement plans on a tax-deductible basis. Based on the tax-deferred eligibility of the group, funding into the plan by the employer is paid with pre-tax dollars
Personal Uses
On the individual level, an annuity is used to provide a future stream of income for the individual to serve as retirement income, or as a source of funding for higher education, such as through an Individual Retirement Annuity (IRA).
Annuity Riders
As with a life insurance policy, riders can be added to an annuity to provide additional benefits for the annuitant. While an annuity rider typically requires additional premium, the benefits provided by such rider can greatly benefit the annuitant in the future.
Annuity riders commonly added to an annuity include long-term care riders, guaranteed monthly income riders and death benefit riders, each providing extra benefits to the owner of the annuity as well as extra financial protection for the annuitant.
Insurance Aspects of an Annuity
Although an annuity contract is not the same as a life insurance policy, both contracts can create similar protection depending on the structure of the annuity. It is important to realize that an annuity is not life insurance, and each is treated and taxed differently.
Most commonly, an annuity provides living benefits for the contract’s owner, who is also the contract’s annuitant; however, some annuities are designed to be similar to the type of financial protection provided by a life insurance policy. An annuity owner can pay the contract’s premiums and taxes on earned interest and designate another individual as the contract’s annuitant, who receives the distributed funds during the contract’s designated annuity period.
Owner-Driven vs. Annuitant-Driven Structure
An example of when an annuity owner is not the annuitant is in an ‘owner-driven’ annuity structure. This type of annuity structure involves the owner and annuitant being two separate individuals and is designed to benefit the annuitant upon the death of the annuity’s owner.
In comparison, the more common ‘annuitant-driven’ annuity structure involves the owner and annuitant being the same individual, and at the point of annuitization, payments are made back to the owner/annuitant or the designated beneficiary in the event that the owner/annuitant dies within the contract’s annuity period.
Premium Payment Options
Single (Lump Sum)
The most common premium option is the single, lump-sum option. This single payment is invested by the contract owner initially and continues to grow as the insurer reinvests the annual earned interest back into the annuity.
Level
This type of premium structure allows an annuity contract owner to make equal premium payments to the insurer on a scheduled basis, such as on a monthly, quarterly, semi-annual, or annual basis. As premium deposits are made by the contract’s owner, both the invested principal and earned interest continue to build and grow the annuity.
Flexible
This type of premium structure allows an annuity contract owner to vary the annuity’s premium deposit amounts at his or her discretion to better follow his or her budget, although a minimum and maximum premium payment level are enforced by the insurer.
Annuitization Time Frames (Immediate vs. Deferred)
Single Premium Immediate Annuity (SPIA)
Designed as a means of spreading out a lump-sum of money over a specified period of time, an Immediate Annuity begins to distribute funds immediately after the first payment period (depending on payment frequency: monthly, quarterly, semi-annual, or annual), and is used when a single, lump-sum premium is deposited by the contract owner with the intent of distributing it over a specified period of time to the annuitant (again, the annuity owner and the annuitant can be the same person or two separate people).
Single Premium Deferred Annuity (SPDA)
A Deferred Annuity delays payout to allow interest to compound over a period of time. Again, an annuity is not taxed during the accumulation period to allow interest to build a quicker rate, thus providing a larger investment return for the annuitant. A deferred annuity can be paid with a single premium, known as a Single Premium Deferred Annuity (SPDA), or through multiple premium deposits.
Flexible Premium Deferred Annuity (FPDA)
Some insurers provide additional flexibility by offering a multiple premium, deferred annuity that allows the contract owner to control the premium deposit amounts and frequency within certain limits stated in the contract, known as a Flexible Premium Deferred Annuity (FPDA).
Enacted in 1997, the Health Insurance Portability and Accountability Act, also referred to as HIPAA, provides for the portability of group insurance between employer group insurance plans and from an employer-sponsored plan to an individual policy if the individual becomes self-employed.
HIPAA includes several common components, one of which is that a new employer must offer continual coverage to a new employee if the employee is switching from a prior employer’s coverage and was insured for at least the previous 18 months on the prior group plan.
Another component of HIPAA includes its length of coverage. Insurance portability through HIPAA is mandated for 63 days between employment periods to allow sufficient time for an employee to switch insurance coverage. Individual insurance through self-employment is considered portable from group insurance as well.
As defined by the Centers for Medicare & Medicaid Services, the Mental Health Parity and Addiction Equity Act of 2008 (MHPAEA) is a federal law that generally prevents group health plans and health insurance issuers that provide mental health or substance use disorder (MH/SUD) benefits from imposing less favorable benefit limitations on those benefits than on medical/surgical benefits.
MHPAEA originally applied to group health plans and group health insurance coverage and was amended by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively referred to as the “Affordable Care Act”) to also apply to individual health insurance coverage.
The US Department of Health and Human Services (HHS) has jurisdiction over public sector group health plans (referred to as “non-Federal governmental plans”), while the Departments of Labor and the Treasury have jurisdiction over private group health plans.
Favorable Tax Treatment of Personal Life Insurance and Annuities
The Internal Revenue Service administers and regulates taxation on life insurance, annuities, endowments and other retirement funds, including individual retirement accounts. Having a basic understanding of the various taxes involved with these contracts is important in understanding their structure and how they qualify (or don’t qualify) for favorable tax treatment by the IRS.
Knowing how taxation is levied on each type of contract can be understood through how the money within these contracts is exchanged. When a ‘taxable event’ occurs, the IRS levies an ordinary income tax on the money being exchanged as these events result in actual income being earned on behalf of a policyowner or beneficiary (based on the death benefit payout) and distributed as income payments.
Policy Funding and Accumulation
Neither life insurance nor annuity premiums are tax deductible for any type of life insurance policy or annuity, except for a percentage of an individual’s contribution in an individual retirement account or individual retirement annuity.
Interest earned on a life insurance policy is part of the policy’s ‘cash value accumulation,’ and is considered deferred income, taxed only when policy funds are distributed from the investment. Allowing interest to grow at a compounded rate without taxation over the policyowner’s lifetime provides a much greater return on the invested funds.
Similarly, while in the accumulation period, an annuity accumulates earnings on a tax-deferred basis since funds are reinvested into the annuity and not distributed to the policyowner. Again, the annuity accumulates cash value through principal and earned interest and is considered deferred income, tax-deferred until the fund annuitizes and begins distributing income to the annuitant.
Cash Value Increases
Compared to most investments which are taxed as ordinary income on an annual basis, life insurance provides individuals a means of tax-deferred growth. In addition, most investment distributions are taxed as ordinary income to the beneficiary of the contract in the event of the contract owner’s death. Life insurance, in comparison, provides the policyowner’s beneficiary with a tax-free distribution of the death benefit.
Although most individuals purchase life insurance to provide future financial protection for their survivors’ well-being, it provides an attractive return on investment, in addition to receiving favorable tax treatment, and can be misused as a ‘tax shelter’ for funds that should otherwise be taxed as earned income.
To curb the increase in life insurance as an investment vehicle and tax shelter, Congress has created a set of tests for a life insurance policy to qualify for a tax advantage and avoid the tax-shelter scenario.
CVAT vs. GPT
Cash Value Accumulation Test (CVAT)
Using the cash value accumulation test, the policy’s cash value must not exceed the amount that would be required as a lump-sum premium to fully pay off the policy based on the policy’s face amount, based on the age of the insured.
Guideline Premium Test (GPT)
Using the guideline premium test, the policy’s premiums cannot exceed the amount that would be required to fully pay off the policy based on the policy’s face amount, as well as the age of the insured.
The primary difference between the cash value accumulation test (CVAT) and the guideline premium test (GPT) is that the CVAT pertains to cash value limits relative to the policy’s death benefit, while the GPT pertains on premium limits relative to the policy’s death benefit. If the cash value or premiums paid exceed the amount allowable under either test, the policy is no longer considered life insurance and is taxed the same as an investment (as ordinary income).
Again, these tests are guidelines to ensure that a policy continues to qualify as life insurance and receive favorable tax treatment. If a policy does not pass one of the two tests required by the IRS, it is not considered to be true life insurance and is taxed the same as a non-qualified investment plan; although, most insurers provide notice to their policyowners before such an event occurs to avoid this taxation issue.
While most individuals never contribute amounts high enough to require the use of these tests, the IRS uses these tests to prohibit investors from potentially exploiting the tax advantages associated with true life insurance.
Dividend Returns
Dividends paid out to participating policyowners in a mutual life insurance contract are considered to be a reimbursement of premium paid to the insurer and are paid back on a tax-free basis; however, any interest paid to policyowners in addition to the premium reimbursement is considered to be income and is taxable.
Policy Loans
Another tax advantage associated with life insurance is the ability to withdraw funds in the form of a policy loan without being taxed. Since a loan must be paid back, including accrued interest, it is not taxed; however, if the policyowner surrenders his or her policy, an income tax is levied against any gain in the policy’s loan value amount.
If the policyowner dies before repayment of the loan, the policy’s death benefit is reduced by the amount of outstanding loan and accrued interest, with the remainder lump sum being tax-free for the beneficiary (unless a recurring payment option is selected).
Policy Settlement Options
Policy surrenders
In the event that a policyowner surrenders his or her policy to the insurer, proceeds equaling the premium paid into the policy are tax-free, while policy surrender proceeds that exceed the cost of the policy are taxable by the IRS. Any pre-tax premium payments and interest earned before forfeiting the plan are taxable as earned income.
Accelerated benefits and Viatical settlements
Under current laws, as long as a policyowner is considered to be chronically or terminally ill, both accelerated benefits and policy proceeds from a viatical settlement are paid out on a tax-free basis.
Death Benefit Proceeds
Death benefit proceeds are paid income tax-free to a policy’s beneficiary if it is paid out as a lump-sum amount. If the beneficiary elects to receive continual income payments, or ‘installments,’ from the death benefit, instead of the lump-sum amount, only the interest that accrues from the principal is taxed as ordinary income to the beneficiary, but not the actual death benefit amount.
Group Life Insurance
Group life insurance includes certain tax advantages for businesses as a means of promoting group insurance for employees. Premiums paid by the employer are tax deductible for the employer as a form of business expense.
In a group life policy, employee premium contributions are not tax deductible; however, employees do not need to report their employer-paid premiums as income as long as their policy coverage is $50,000 or less. This is due to the fact that policy premium payments by the employer are not considered income to the employee up to the first $50,000. If, however, the policy coverage exceeds $50,000, the employee is taxed on any excess premium above this limit, as this amount is considered taxable annual income.
Group policy death benefit proceeds are similar to individual policies where the benefit is tax-free if taken as a lump-sum by the beneficiary. If installment benefits are chosen by the beneficiary, any interest earned on principal is considered earnings and is taxed accordingly.
Values Included in an Insured’s Estate
Upon the death of an insured individual in a life insurance policy, federal and state inheritance estate taxes are mandated for policy proceeds that are included in the estate of the insured.
To avoid this estate tax, the insured can transfer ownership of his or her life contract to the designated beneficiary, but the transfer must be completed at least three years before the death of the insured. Under the ‘three-year look back’ rule, the IRS can still levy estate taxes on the insured’s estate if a transfer of ownership to the beneficiary occurs within three years of the insured’s death.
Enacted in 1989, the Omnibus Budget Reconciliation Act, also referred to as OBRA, extends COBRA continuation benefits from 18 months to 29 months for disabled employees at the time of the qualifying event or who become disabled during the first 60 days of COBRA coverage who do not already qualify for 36 months under COBRA.
The Omnibus Budget Reconciliation Act (OBRA) also clarified Medicare as an ‘entitlement’ program which allows eligible Medicare recipients to sign up for Medicare coverage before becoming disqualified and thus losing continuing health coverage through COBRA or OBRA.
Enacted in 1985, the Consolidated Omnibus Budget Reconciliation Act, also referred to as COBRA, extends group health coverage to former employees and their families for up to 18 or 36 months after termination of employment. Under this federal law, an employer group must consist of at least 20 employees.
The premium rate under COBRA remains the same for the terminated individual as it was while the individual was covered under the group policy; however, the terminated employee typically begins paying the entire premium, often paying more than when he or she was covered under the group policy. Often times this increase in payment is confused for an increase in the premium rate, but in actuality, the increased amount paid by the individual is a result of the employer ceasing contributions to the individual’s premium once he or she is terminated from group coverage. Under COBRA, the terminated employee is responsible for paying the entire premium rate for his or her policy.
Terms and Limitations of COBRA
Qualifying for COBRA occurs when the employee, spouse, or dependent child becomes ineligible for coverage under the group insurance. Examples include family coverage after the death of a covered employee, termination of employment or reduction of hours under full-time status, Medicare eligibility, legal separation spousal coverage, child ineligibility on the group plan, or if the employer declares bankruptcy and employment ends. Employee termination resulting from misconduct does NOT qualify under COBRA.
A qualified beneficiary is considered to be anyone covered under the group policy the day before the qualifying event occurs and normally includes the employee, spouse, and dependent children.
A written eligibility notification, also known as a Notification Statement, must be given to employees, their spouses and any other dependents on the policy by the employer when the employee group becomes eligible for COBRA coverage, or when a qualifying event occurs. Federal law requires a 60-day period to elect COBRA coverage, after which the employee is no longer eligible.
The purpose of continuation coverage is to provide time for the terminated employee to either apply for new coverage under a new group plan or apply individually (or become eligible for Medicare).
Qualifying Events for 18 Months of COBRA
- Termination of employment (most common)
- Hours of employment are reduced
When an employee’s position within a company is terminated, or when an employee’s hours are reduced below the minimum required to be eligible through the employers’ group policy, he or she is removed from the company’s group health policy. The additional 18 months provided under COBRA provides this employee with time to find new coverage.
Qualifying Events for 36 Months of COBRA
- Coverage for surviving dependents of a deceased employee
- Former spouse of an employee after legal separation or divorce
- Dependent children that no longer qualify as dependent
COBRA coverage ends when a disqualifying event occurs such as failure to pay premium, Medicare entitlement, or once new insurance is issued.
Enacted in 1973 as a result of the Civil Rights Act, the Pregnancy Discrimination Act, prohibits employers with fifteen (15) or more employees, as well as all state and local government employees, from discriminating against pregnant women in regards to childbirth or related medical conditions.
Women who are pregnant or are affected by pregnancy-related medical conditions are covered under this law. As an exception to this law, costs associated with abortion are not required to be covered, unless the life of the mother is endangered.
Under this law, pregnant employees must be able to continue to work for as long as they are able to perform their work duties, and employers are prohibited from requiring any set period of time off after childbirth before allowing the woman to return to work.
Employer-sponsored health insurance must cover expenses for pregnancy-related conditions on the same basis as for other medical conditions and cannot require any additional or increased deductible amount. Employers must provide the same coverage for the spouse of a male employee as they do for the spouse of a female employee.
Enacted in 1993, the Family and Medical Leave Act, also referred to as the FMLA, provides ‘eligible’ employees with the ability to take an unpaid leave of absence of up to twelve (12) workweeks during any 12-month period for certain qualified medical, family and military reasons. An employee becomes eligible for FMLA protection upon being employed by the same employer for at least one (1) year and has worked for 1,250 hours over the previous 12 months.
Under this Act, employers are required to maintain the employee’s health coverage under the employer’s group health plan as well as any other employment benefits in the absence of the employee. In addition, an employer must accept an employee back to the company after a qualified FMLA period of absence for the same or an equivalent job position as before taking such leave of absence.
The Department of Labor provides 12 weeks of unpaid, job-protected coverage under FMLA for the following reasons:
- The incapacity of the employee due to pregnancy, prenatal medical care or child birth as well as to care for the employee’s child after birth, or adoption
- A serious health condition that makes the employee unable to perform the essential functions of his or her job
- To care for the employee’s spouse, child or parent who has a serious health condition
As defined under the FMLA, a ‘serious health condition’ is an illness, injury, impairment or physical or mental condition that involves either an overnight stay in a medical care facility, or continuing treatment by a health care provider for a condition that either prevents the employee from performing the functions of the employee’s job, or prevents the qualified family member from participating in school or other daily activities.
Enforced by the Department of Labor, all State and Federal agencies and employers, as well as private employers with 50 or more employees within 75 miles of the employer must provide such employment protection. Eligible employees are responsible for providing sufficient information and documentation pertaining to a need for a leave of absence and should provide advance notice, when possible, of 30 days before needing to take such leave from employment.
Taxation of Individual Health Insurance
Medical Expense Insurance Premiums and Benefits
Medical expenses that are covered through an insurance policy, such as an operation or the cost of services for a doctor’s visit, are considered ‘reimbursed’ medical expenses and cannot be deducted from a policyholder’s annual income.
Medical expenses that are not covered through an insurance policy, such as policy premiums, deductibles, copays, coinsurance amounts, and medical expenses not reimbursed through the policy, are considered ‘unreimbursed’ medical expenses.
Unlike reimbursed medical expenses which cannot be deducted, unreimbursed medical expenses can be deducted only if the policyholder’s annual unreimbursed medical expenses exceed 10% of his or her adjusted gross annual income. If he or she exceeds this 10% threshold, only the excess of 10% will be considered tax deductible.
Example 1
Tim’s unreimbursed medical expenses equal $4,500 and his adjusted gross income for the year is $50,000. Based on his adjusted gross income, he would not be able to deduct any unreimbursed medical expenses because he did not exceed the 10% or $5,000 ($50,000 x 10% = $5,000) threshold.
Remember, if the policyholder’s annual unreimbursed medical expenses do not exceed 10% of his or her adjusted gross annual income, none of the unreimbursed medical expenses are deductible.
Example 2
Tim’s unreimbursed medical expenses equal $4,500 and his adjusted gross income for the year is $40,000. Based on his adjusted gross income, he would exceed the 10% ($40,000 x 10% = $4,000) threshold and would be able to deduct $500 ($4,500 – $4,000 = $500) of his unreimbursed medical expenses.
Note: Individuals born before January 2, 1950 can deduct annual unreimbursed medical expenses that exceed 7.5% of their adjusted gross annual income, as opposed to 10% for individuals born on or after this date.
Medical expense policy benefits are received tax-free by the insured; however, it is important to note that medical expense benefits cannot exceed actual medical expenses incurred by the insured.
Long-term Care Insurance Premiums and Benefits
Both medical expense and long-term care policy premiums are considered medical expenses, and are included in annual deductions when meeting the 10% or 7.5% unreimbursed medical expense thresholds.
LTC benefits are received income tax-free by the insured up to the amount of incurred expenses. Any benefits exceeding the actual costs by the insured are considered taxable, as is the case under a fixed benefit LTC policy when daily benefits payable exceed daily expenses incurred.
The 10% and 7.5% expense limits apply to medical expense and long-term care policies, but do not apply to disability insurance.
Disability Insurance Premiums and Benefits
Premiums paid for individual disability insurance are not tax deductible from a policyholder’s annual income; however, disability income payments are received income tax-free by the insured and are usually expressed as a percentage of the insured’s pre-disability income amount.
Disability benefits cannot exceed pre-disability income levels and are often paid out as a percentage of the insured’s actual pre-disability income amount to encourage the individual to return back to work as soon as possible to reach his or her full pre-disability earnings.
Individuals who are considered chronically ill must be re-certified as such by their insurer on an annual basis to continue to receive disability benefits on a long-term basis.
Taxation of Group Health Insurance
Employer-based group health insurance represents the majority of the health insurance in America. Many employers provide health insurance in the form of medical expense coverage, LTC and disability income policies for employees as a benefit of employment.
Group Medical Expense Insurance Premiums and Benefits
Employee-paid premium contributions in a group medical expense policy are not tax deductible; however, employer-paid premium contributions in a group policy are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income.
Employee medical expense benefits are received income tax-free, but benefits cannot exceed actual expenses.
Similar to personal excess medical expenses, if an employee’s annual unreimbursed medical expenses exceed 10% of his or her adjusted gross annual income (7.5% for individuals born before January 2, 1950), any unreimbursed medical expenses that exceed this 10% (or 7.5%) are deductible from the employee’s annual income.
Group Long-term Care Insurance Premiums and Benefits
Employee-paid premium contributions in a group long-term care policy are not tax deductible; however, employer-paid premium contributions in a group policy are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income.
LTC benefits are received income tax-free by the insured up to the amount of incurred expenses. Any benefits exceeding the actual costs by the insured are considered taxable, as is the case under a fixed benefit LTC policy when daily benefits payable exceed daily expenses incurred.
Similar to personal excess LTC expenses, if an employee’s annual unreimbursed LTC expenses exceed 10% of his or her adjusted gross annual income (7.5% for individuals born before January 2, 1950), any unreimbursed LTC expenses that exceed this 10% (or 7.5%) are deductible from the employee’s annual income.
Group Disability and AD&D Insurance Premiums and Benefits
Employee-paid premium contributions in a group or franchise disability or AD&D policy are not tax deductible; however, employer-paid premium contributions are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income.
Employee AD&D benefits are received income tax-free; however, an employee’s disability income (DI) benefits are received income tax-free in proportion to the benefits that represent the employee’s premium contributions. This means that the employee’s disability income benefits are taxed as income to the employee in proportion to the benefits that represent the employer’s premium contributions to the policy.
As an example, If an employer pays 100% of the group disability insurance premium for its employees (100% employer contribution), then benefits are 100% taxable as income to the employees; if however, the employer pays 50% and the employee pays the other 50% of the premiums, only the portion of benefits that is attributed to the employer’s premium payment is taxable as income to the employee. Although employees’ premium contributions are not tax deductible from annual income, their 50% paid portion of disability income benefits is received income tax-free.
As a final example, if the employees contribute 100% of the premium payments toward their group disability policy, then 100% of the disability income is received income tax-free for the employees.
FICA Taxation
As is the case with ordinary income, employees are also responsible for paying Social Security FICA taxes on the portion of disability income earned under the DI policy that was funded by the employer’s premium contributions for a 6 month period following the beginning of the DI benefit period, since this portion is considered to be earned income by the employee and would otherwise be taxed as part of the employee’s payroll under FICA.
Group Sponsor Taxation
Employer Taxation
Employer-paid premium contributions for group medical expense, disability and AD&D policies are all deductible as a business expense for the company because they serve as otherwise ordinary income that would be paid to the employee. Except for cafeteria plans or flexible spending accounts, LTC policies are also deductible as a business expense for the company.
Small business overhead expenses (BOE) are tax deductible as a business expense whether it is a self-employed sole proprietorship, partnership, or corporation.
Self-Employed Taxation
Self-employed individuals, sole proprietors, and partnerships can deduct 100% of their annual unreimbursed medical expenses, however, disability insurance taxation rules apply the same as they do for individual DI policies (taxable premiums and tax-free benefits).
Key Person Taxation
In regards to a ‘key person’ disability income policy or a partnership ‘buy-sell’ disability policy, since the business is providing protection for itself against the loss of one of its key executives or members, the company’s premiums are not tax deductible as a business expense; however, benefits are received income tax-free to the business.
Taxation of Health Spending Accounts
Health Savings Account (HSA)
An HSA is a popular type of medical expense savings account is used both personally, as well as in a group health policy to help control premium costs and to provide better management of an individual’s health needs. Pre-tax employer contributions, as well as after-tax personal contributions are deposited into the HSA, enabling it to grow tax free just like an ordinary savings account. Pre-tax contributions are taxable as income upon distribution followed by the reimbursement of any after-tax contributions.
Employer contributions to an employee’s HSA are excluded from an employee’s taxable income, thus lowering the employee’s taxable income. In addition to the tax-deferred earned interest of an HSA, an insured can withdraw funds from the account on a tax-free basis for ‘qualified’ medical expenses such as unpaid hospital or Medicare expenses, doctor’s fees and prescription costs, as well as other costs outlined in the HSA contract.
Unqualified withdrawals from an HSA before the age of 65 years old are subject to ordinary income taxation, as well as a 20% ‘early withdrawal’ penalty tax. HSA distributions made once the individual reaches 65 years old are only subject to ordinary income taxation for the year in which they are received by the insured.
Health Reimbursement Account (HRA)
The IRS levies similar taxation on an HRA as it does with an HSA. Employer contributions to an employee’s HRA are considered to be tax deductible as a business expense for the company because they serve as otherwise ordinary income that would be paid to the employee.
Employee-paid premium contributions in an HRA are not tax deductible; however, employer-paid premium contributions in an HRA are not taxable to the employee and are not included in an employee’s annual income, thus lowering the employee’s taxable income. Employee benefits received through the HRA are received income tax-free.
