Extended Care Planning Using 1035 Exchanges

Ways to protect retirement plan assets from long-term care expenses


You can protect retirement plan assets from the financial risks of long-term care expenses and help preserve an estate for future generations. One of the ways to do this is by using provisions of the Pension Protection Act of 2006. The act allows the surrender of cash value from a non-qualified tax-deferred annuity to be used to pay a long-term care (LTC) premium and not be considered taxable income.

The Internal Revenue Code Section 1035 allows the exchange of cash value from an existing annuity contract for a new LTC policy, without paying tax on the investment gains earned in the original contract. These transactions are often referred to as a “1035 Tax-Free Exchange.”

Some reasons to do a 1035 exchange is that the LTC policy provides tax-free benefits should the insured become benefit eligible. A new LTC policy could be better suited for current and future needs than an existing annuity contract that no longer meets the purpose for which it was originally intended.

Partial or full 1035 exchanges

Some annuity carriers allow what is called a “partial 1035” of cash value out of their contract. This could allow some flexibility in purchasing a new LTC policy. If the carrier does not allow a partial exchange then you have to do a full 1035 exchange and take all the surrender cash value.

When designing a plan of care, knowing the amount of the proceeds you have to work with will allow you to back into the various options for the client. This includes: the daily benefit amount, length in years for the benefit to last, elimination periods for assisted living and home care, and the inflation options.

Questions to Ask

As the client advisor, help them do their homework and ask the annuity carrier some important questions upfront in the planning stages.

• What is the current cash surrender value
• What are the surrender charges if any
• What is the policy anniversary date
• Do you allow a partial surrender?

Once you are armed with all the answers, you can back into a proposal. Some pre-medical underwriting might be necessary before submitting the application. Issue ages can go up to 79 years of age.

New consumer features

Make sure your state allows a single premium into a traditional LTC policy like the National Guardian Life. This means that the coverage is guaranteed for life. No more premiums will be required. Another new option is called a lifetime benefit feature instead of the traditional 2, 3, 4 or 5 year benefit plan.

Call to action

Agents and brokers should review all their existing non-qualified annuity contracts and perform a due diligence review to see if moving the annuity to a LTC policy is in the best interest of the client. Also, in meeting new clients as you fact find their current assets always ask if they have any non-qualified annuities in their portfolio. You just may be pleasantly surprised.

Underwriting homework upfront

You have to qualify for long-term care coverage. That entails considering a client’s current age, health, medications and current medical treatments. Carriers have pre-submission tools that can help clients know if they should move forward with the application process.

Items that can disqualify an application could be height and weight, certain medications and conditions such as Alzheimer’s disease, dementia, congestive heart failure, type 1 diabetes, oxygen use and Parkinson’s — to name a few.

All carriers provide agents with underwriting guides that list the conditions and medications. Other items that could make a client ineligible for coverage would be that they were previously declined for coverage, or that they currently require assistance with the activities of daily living, use a walker, wheelchair or are non-compliant with medications and treatments.

Some of today’s biggest medical concerns for the underwriters are depression, by-polar diagnosis, insulin dependence, diabetes, orthopedic problems, sleep apnea, cognitive dementia and memory loss, family history, obesity and circulatory issues and what are called co-morbid conditions — having more than one major medical issue.

What care costs

The top reason one would buy a long-term care plan is to allow your loved ones to care about you instead of caring for you. Other reasons include to remain independent, to have a choice where to receive care, and to avoid burdening loved ones with caregiving roles. The cost for home care today in Sacramento, Calif. is around $28-32 dollars per hour. A one bedroom assisted living community starts around $5,000. A good source of information based on location is a website called ‘whatcarecosts.com.’

New for 2022

Besides paper applications, clients can now do an electronic application with their agent through I-GO/E-APP and do it all online. S0, start taking a look at all those non-qualified annuities and see if you can put those dollars to better use with a long-term care policy for your client.

Timely long-term care decisions suffer from denial of eventualities
Consider these recent findings from AARP:

• Someone turning age 65 in 2020 had a 70% chance of needing long-term care in their remaining years, according to the U.S. Department of Health and Human Services (HHS).

• The average person who needs help, at home or elsewhere, needs it for three years, but 20% need it for at least five years, HHS says. About one-third need nursing home care for an average of 1 year.

• The cost of such care varies widely across the United States. In 2021, the median monthly cost was $5,148 for a home health aide, $4,500 for an assisted living facility and $9,034 for a private room in a nursing home, according to a survey by Genworth.

• Despite those needs, just 18% of adults over 40 have looked into long-term care planning for themselves; a third have helped an older family member get information, says an AARP survey conducted in 2020.

Turning Denial Into Action
Ready to start a conversation about long-term care, for yourself or a family member, but don’t know where to start?

You can learn the basics, about services, how to pay for them and how to prepare, at the U.S. government’s LongTermCare.gov website. The site includes tips for anyone, healthy or not, over age 50.

But navigating the emotional terrain of these conversations can be tricky. A few expert tips:
If talking with a reluctant family member, focus on your love and concern, says life care planner Jennifer

Crowley: Say that “it would mean a lot if you could just kind of look ahead at some of these things that are worrying you.” If a loved one still doesn’t want to talk? Ask yourself, “Am I the best person to be having this conversation?” suggests eldercare consultant Joy Loverde. Sometimes, a professional life planner, a trusted doctor or a social worker can help.

Listen to your loved one and respect their choices, even if you don’t agree, Crowley says. If you can make just a little headway, she says, focus on “the basics” — such as essential legal documents that say who will make health and financial decisions if the person becomes incapacitated.

Excerpted from AARP: “When Denial Gets in the Way of Long-Term Care Planning”
A common refrain: If we don’t talk about it, it won’t happen

By Kim Painter, AARP



PATRICK ‘PJ’ JOHNSON is an independent life insurance agent and also does sales and marketing for CPS Sacramento. PJ has been a NAIFA member since 1984 and a past board member of the Greater East Bay chapter and past board member of the Sacramento FPA association. He has a CLU and a CLTC designations.
Contact: pj@cpssac.com