Is It or Isn’t It Long-Term Care Insurance?

Why 7702(b) matters for Long-Term Care planning 

By Marc Glickman

Thanks to the conversations happening in states considering a payroll tax to cover a modest state-funded long-term care benefit, there’s more interest in understanding what qualifies as long-term care insurance. California may allow an exemption from the proposed payroll tax if an employee already owns private long-term care insurance. So, it’s important to understand what that means by looking at the product types that may qualify for an exemption.

In this article we explain what section 7702(b) is, how it works, and how it differs from a chronic illness rider (IRC 101(g)).

What is Section 7702(b)?

Not all long-term care insurance policies and riders are created equal. Some may offer more benefits, more flexibility, and more tax advantages than others. 

Section 7702(b) is a part of the Internal Revenue Code (IRC) that defines what constitutes a qualified long-term care insurance contract and how it is treated for tax purposes. According to Section 7702(b), a qualified long-term care insurance contract must meet certain requirements, such as:

  • It must provide only coverage of qualified long-term care services.
  • It must be guaranteed renewable.
  • It must not provide for a cash surrender value or other money that can be paid, assigned, pledged or borrowed.
  • It must provide refunds (other than refunds on the death of the insured or complete surrender or cancellation of the contract) and dividends under the contract be used only to reduce future premiums or increase future benefits.
  • It must meet certain consumer protection standards set by the National Association of Insurance Commissioners (NAIC).

Qualified long-term care services are defined as necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services that are:

  • Required by a chronically ill individual; and
  • Provided pursuant to a plan of care prescribed by a licensed healthcare practitioner.

A chronically ill individual is someone who has been certified by a licensed health care practitioner as:

  • Being unable to perform at least two activities of daily living (such as eating, bathing, dressing, toileting, transferring and continence) without substantial assistance from another individual for at least 90 days due to a loss of functional capacity; or
  • Having a severe cognitive impairment (such as Alzheimer’s disease or dementia) that requires substantial supervision to protect his or her health and safety.

Why is Section 7702(b) Important?

Section 7702(b) is important because it provides certain tax benefits for qualified long-term care insurance contracts. Specifically:

  • The premiums paid are treated as medical expenses and may be deductible (subject to certain limits) if the taxpayer itemizes deductions on Schedule A.
  • The benefits received are generally excluded from gross income as amounts received for personal injuries or sickness.
  • Business owners may be able to take a first-dollar tax deduction as a business expense on some or all the qualified long-term care insurance premiums for themselves or employees.
  • Individuals may be able to withdraw premiums as a qualified medical expense pre-tax from a health savings account (HSA), health reimbursement arrangement (HRA), or medical savings account (MSA) annually up to an age-based limit.
  • States considering a payroll tax to fund a minimum long-term care benefit may exempt individuals from the tax if they own a long-term care policy that meets the 7702(b) requirements.

These tax benefits can make qualified long-term care insurance contracts more affordable and attractive for consumers who want to protect themselves from the high costs of long-term care.

What are 7702(b) Qualified Riders?

Besides a 7702(b) traditional LTCi policy, a 7702(b) rider is an add-on or feature to a life insurance policy or an annuity contract that provides long-term care benefits in accordance with Section 7702(b). It allows the policyholder to access some or all the death benefit or cash value of the policy or annuity while he or she is alive if he or she becomes chronically ill and needs long-term care services.

A 7702(b) rider can offer several advantages over a stand-alone long-term care policy. It provides multiple benefits in one product: life insurance/annuity plus long-term care coverage. In addition, once the rider is purchased, the premium is often fixed and guaranteed not to increase unless the base policy premium increases. The rider also may preserve some value for heirs if the rider benefits are not exhausted by a long-term care event.

Depending on the type and design of the rider, benefits can be paid out through reimbursement, indemnity, or cash indemnity.

The benefits from the rider will reduce the life insurance death benefit or annuity value by the same amount. If the entire death benefit or annuity value through the rider benefits are exhausted, the policy or contract will terminate, and no further benefits will be payable.

Advantages and disadvantages of 7702(b) riders

A few of the advantages of 7702(b) riders include:

  • Tax advantages: Rider benefits are generally income tax-free if they do not exceed certain limits set by the IRS and premiums may be tax deductible.
  • Flexibility: Rider benefits can be used for any qualified long-term care expenses regardless of where they occur (at home, in a facility, etc.). 
  • Protect and Preserve: No need to purchase a separate stand-alone policy. Preserves some assets for beneficiaries if the entire death benefit or annuity value are not used through the rider benefits.
  • No use-it-or-lose-it risk: Products allow the unused portion of the death benefit to remain intact and paid to the beneficiaries or will even pay a residual death benefit in addition to LTC benefits being used in full.

Disadvantages of 7702(b) Riders

  • Cost: May increase premiums or fees significantly depending on factors such as age, health status, type, and amount of coverage. 
  • Qualification: Some riders have limited health underwriting.
  • Premium payment flexibility: Some products require premiums to be paid over a shorter period such as a lump sum or over 10 years.

Chronic Illness Riders: How 101(g) Riders Differ from LTC Riders

While we’re clearing up confusion, let’s also address the difference between a chronic illness rider and a long-term care rider on a life insurance policy or annuity. A chronic illness rider is a type of rider that meets the requirements of IRC section 101(g), which allows for tax-free payments for permanent qualifying events. Some chronic illness riders also cover temporary qualifying events. A long-term care rider is a type of rider that meets the requirements of IRC section 7702(b), which allows for tax-free payments for long-term care services. Both types of riders can be triggered by the inability to perform two out of six Activities of Daily Living (ADLs) or severe cognitive impairment, as certified by a licensed health care provider.

A chronic illness rider may have some advantages over a long-term care rider, such as:

  • Lower extra rider premium: The additional premium for the chronic illness rider may be low or included in the base life insurance premium. However, this may also mean a lower death benefit.
  • Better life insurance features: Chronic illness riders may offer higher death benefits, more cash value growth, and other features that enhance life insurance protection.
  • Faster product availability: For insurers, the 101(g) filing process may be faster, and agents may not need additional LTC continuing education to sell these products.

A chronic illness rider may have some disadvantages, such as:

    • No uniform benefit language: Chronic illness riders vary widely in their contract terms and conditions. You should pay attention to whether the disability must be permanent, how the chronic illness is defined, how the death benefit is affected, and other contract details.
    • Limited benefit amount: The 101(g) benefit amount may be limited to a percentage of the death benefit. For example, you may only get 2% to 5% of the death benefit per month as a chronic illness benefit.
    • No inflation protection: The benefit amount usually does not increase with inflation and may lose purchasing power over time.
    • Not marketable as long-term care insurance: Chronic illness riders are not allowed to be called long-term care insurance and may be excluded for the purposes of the exemption from a potential payroll tax depending on a state definition.

The bottom line

The confusion about what constitutes long-term care insurance happens as states allow for an exemption from their payroll tax, like Washington and possibly California. Those states may require that a product meet the 7702(b) requirements. Generally, choosing between a long-term care rider and a chronic illness rider depends on several factors, such as health status, financial situation, tax bracket, and personal preferences. However, when considering a product that will qualify as long-term care insurance, make sure that it is compliant with IRC section 7702(b). For that is, indeed, the relevant question.

Marc Glickman, FSA, CLTC, is CEO and co-founder of BuddyIns, a leading long-term care insurance education, marketing and technology company. Marc is a licensed insurance agent in all 50 states and serves on the Board of Advisors for the Certification for Long-Term Care (CLTC.) Marc has over 15 years of experience as an actuary including as the Chief Investment Officer and Chief Sales Officer for a major LTC insurance company. Marc earned his degree in economics from Yale University. In 2019, Marc was named one of the top 20 innovators in the insurance brokerage space.