Take-Away: There is currently a Bill before the House Ways and Means Committee that would permit the conversion of the cash surrender value of a life insurance policy to long-term care coverage without any income tax consequences to the policy owner. This Bill is something we should watch, along with the SECURE Act Bill, which is now on a fast-track before the Senate Finance Committee. Clearly, there is a growing emphasis in Washington on retirement and long-term care funding for our aging population.

Background: It is no secret that America is aging. With an aging demographic comes longer lifespans coupled with a failure to save enough for a comfortable retirement for more years. Add to those facts that dementia is on the rise; demographics and statistics now tell us that between 60% to 80% of dementia diagnoses are in the form of Alzheimer’s disease. It is little wonder then that as Americans age and live longer, their need for long-term care will grow. We should expect more proposals coming from Washington to address this problem of the need by retirees to pay for their long-term care expenses. One such proposed solution is HR 72903.

HR 72903 Proposal:

Tax-Free Sale of Life Insurance Policy: This Bill, if it becomes law, would reduce to zero the income taxes that are due on the sale of an existing life insurance policy, i.e. a life settlement The Bill’s tax-free treatment on the sale would replace the current taxation rules:

  • (i) Tax-free return of premiums paid over the years, i.e. basis;
  • (ii) taxable ordinary income recognized on the difference between the premiums paid on the policy over the years (basis) and the policy’s current cash surrender value; and
  • (iii) capital gain recognized on the difference between the cash surrender value and the purchase price paid in the life settlement transaction.

[Rev. Rul. 2009-12; 2017 Tax Cuts and Jobs Act, Section 13521.]

Long-Term Care Account: To qualify for income tax-free treatment, the sales proceeds that result from the sale of the insurance policy would have to be transferred within 30 days of the insurance policy’s sale to a long-term care account. Like an IRC 529 account, the long-term care account would be “exempt from taxation” as long as the account was used to pay for qualified long-term care expenses.

Distributions from Long-Term Care Account: Distributions from the long-term care account would be tax-free to pay for “qualified long-term care services.” In addition, the distributions could be taken from the account, tax-free, to pay for “premiums for qualified long-term care contracts.”

Spouses Covered: Interestingly, the use of tax-free distributions from the account would be not only for the former policy owner who funded the long-term care account and incurs the long-term care expenses, but also the owner’s spouse. After the death of the long-term care account owner-beneficiary, the account would automatically revert to the beneficiary’s spouse without any income tax consequence.

Conclusion: For all we know, HR 72903 may never become law. However, it’s appearance a positive sign that someone in Washington DC is actually thinking about the financial needs of an aging population and the high probability that long-term care expenses will be incurred by that large segment of the populace. Not every life insurance policy will be a good candidate for a life settlement transaction but it may be yet another reason for the owners of old life insurance policies to sit tight and not surrender the policy for its cash surrender value.