The Problem with Annuities and How to Solve It (Part 2) #Annuities

                Last week I was outlining the problem with annuities.  What I am specifically referring to is the tax deferred status of annuities.  While the growth inside these investments is not taxed until monies are withdrawn, they are taxed as ordinary income and if left to heirs there is no step up in basis to avoid the tax like there is in the case of stocks and real estate.  Often these annuities will pay out on an accelerated basis at death, causing a large tax hit.

                Americans own billions of dollars of deferred annuities.  Less than 2% of annuity owners ever annuitize them – turn on the guaranteed income stream that is one of the primary advantages of these investments.  Instead they leave these assets untouched to their heirs – with the very large tax bill that goes along with it.

                There is, however, a way to avoid the taxes on these assets and at the same time pay for your long term care should you need it and protect your other assets from having to be spent towards that care.  That’s because Congress passed a law in 2006 that allows for the withdrawal of tax deferred growth from annuities, that if done in certain ways, will be entirely exempt from income tax.

                The law is called the Pension Protection Act of 2006 #PensionProtectionAct and the specific provisions I am talking about became effective in 2010.  I wrote about it in this blog 2 years ago (see my posts dated 8/25/14  http://www.hauptmanlaw.com/2014/08 and 9/1/14 http://www.hauptmanlaw.com/2014/09 ).

                Individuals who own annuities can now add long term care riders with special tax advantages.   The Pension Protection Act allows the cash value of annuity contracts to be used to pay premiums on long term care contracts.  Money coming out of the annuity in this way is treated as a reduction of the cost basis of the annuity and thus is non-taxable.

                Additionally, the Act allows annuity contracts without long term care riders to be exchanged for contracts with such a rider in a tax free transfer under Section 1035 of the Internal Revenue tax code.   This is especially helpful to the many individuals who own annuities that have a low cost basis and have allowed their investments to grow without previously taking out any of the growth.  The annuity’s cash value can be used to purchase long term care coverage, and there is no tax owed because the exchange of one contract for another does not trigger any income tax that would normally be owed upon the sale of the current annuity.  It’s all because of Section 1035 of the IRS tax code.

                Even better is that many people who passed on traditional long term care insurance in the past and are too old or not healthy enough to get it may just get a second chance.  That’s because the underwriting requirements for annuities is a lot less strict than it is for long term care insurance or life insurance with accelerated benefits for long term care.  Insurance companies will offer some of these products to people as old as 85.

                Next week we’ll take a look at a closer look at these products and how they work.