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Requiring long-term care later in life can be pricey. According to SeniorLiving.org, the median annual cost for nursing care in a semi-private room is $131,580. For most seniors, that amount would quickly exhaust their assets. Buying long-term care insurance is one option for offsetting these costs, but rising premiums can make that expensive, too. A long-term care annuity may be a better choice for helping you plan for the future.
A financial advisor can answer your questions about long-term care planning and other retirement strategies.
What Is a Long-Term Care Annuity?
An annuity is an insurance contract in which you pay a premium, either upfront or monthly, to receive payments back from the insurance company at a later date.
An annuity can be immediate, meaning your annuity payments begin within a year of paying the initial premium. Or, it may be deferred, with payments beginning at a specified date in the future, such as your 65th birthday.
A long-term care annuity is a deferred annuity that includes a long-term care rider. An annuity rider is an optional add-on you can include when buying an annuity that offers extra features or benefits.
Say, you purchase an annuity with a long-term care rider. Then, when you eventually need long-term care, you receive payments from the annuity to help with those expenses. These payments can be made to you monthly or as a lump sum. Your annuity company will either give you funds to use as needed or reimburse you for expenses after you have paid them.
To activate the long-term care rider and begin receiving benefits, you must meet medical standards that necessitate long-term care. For example, that might mean being diagnosed with Alzheimer’s disease or another chronic illness that requires round-the-clock care, either at home or in a nursing facility.
Annuities grow with interest, and a long-term care annuity can either be fixed or variable.
- Fixed annuity. With a fixed annuity, you’re earning a guaranteed rate of return. This type of annuity is generally considered a safe investment since your returns are predictable.
- Variable annuity. A variable annuity tends to be riskier. But, if the underlying investments perform well, there’s the opportunity for higher returns.
What Are the Pros of a Long-Term Care Annuity?
Adding a long-term care rider to an annuity could be a good option to consider if you’re looking for long-term care coverage but don’t want a separate insurance policy.
In a way, this rider provides the best of both worlds. It’s a regular annuity payment you can rely on for retirement, with the extra protection of long-term care coverage that will pay medical care costs.
There’s another advantage, especially if you have an existing health issue. You may find it easier to get approved for an annuity with a long-term care rider versus long-term care insurance.
For example, you may run into fewer hassles with a long-term care annuity if you’ve had a hip replacement or similar surgery compared to long-term care insurance. However, conditions like Parkinson’s disease may not be eligible for coverage either with a long-term care rider or a long-term care policy.
Cost-wise, a long-term care annuity could be a more budget-friendly option. Long-term care insurance premiums are dependent on several factors:
- Home state
- AgeGender
- Individual or joint coverage
- Your preferred payout schedule
- Dollar amount of preferred benefits under policy
With a long-term care rider, your age and overall health can affect the cost. But, you may pay less in premiums for coverage.
What Are the Cons of a Long-Term Care Annuity?
There are a few drawbacks to keep in mind when considering a long-term care rider.
For one thing, you may be expected to pay a large upfront premium for coverage. The insurance company’s risk assessment will determine how high your premium will be based on the likelihood of you needing long-term care in the future.
Paying it could also be challenging if you don’t have a lot of liquid cash reserves available. You might have to sell off some of your investments or withdraw money from a 401(k) or IRA to cover the premium payment. Worse, this can potentially trigger a tax penalty.
Speaking of taxes, it’s important to mention that annuity payments are taxable. However, their tax treatment depends on how you purchase them.
Suppose you buy an annuity inside a qualified plan, such as a 401(k) or IRA. In that case, the entire annuity is taxable when withdrawn, including the money you used to purchase it and any earnings. If you buy an annuity using after-tax dollars, then only the earnings are taxed when withdrawn.
Long-term care insurance benefits generally are not taxable.
Long-Term Care Annuity vs. Long-Term Care Insurance
A long-term care annuity is different from long-term care insurance in a few ways.
With long-term care insurance, you’re buying an insurance policy specifically for long-term care. You may pay an upfront premium or a monthly premium. Once you need long-term care, the policy can pay out monthly or on a lump-sum basis to help with those costs.
Long-term care insurance doesn’t have the growth component that a long-term care annuity would. Another key difference is that if you don’t need long-term care, you don’t get the premiums you paid back unless you purchase a return of premium rider.
With a long-term care annuity, you could still receive annuitized payments even if you don’t use the long-term care rider’s benefits. In other words, it’s a form of guaranteed income that you can use for long-term care if needed, or for other retirement expenses.
Tax and Estate Planning Considerations
Long-term care annuities carry unique tax characteristics that can influence both retirement income and legacy goals.
Taxes
The key distinction is how the IRS treats the two components of the contract – namely, the annuity itself and the long-term care rider. Payments used to cover qualified long-term care expenses are typically tax-free up to certain limits, as defined under federal tax rules.
However, any payments or withdrawals not used for care are taxed as ordinary income because they represent earnings. This structure allows part of the annuity’s value to serve as a tax-efficient funding source for care while maintaining a predictable income stream.
If the owner never needs long-term care, the annuity continues to function like a standard deferred contract. Earnings remain tax-deferred until withdrawn or annuitized, at which point distributions are taxed as income. The portion of each payment representing the original after-tax premium is not taxed again.
This makes long-term care annuities more flexible than stand-alone insurance, since the funds can still be used for general retirement income rather than being lost if no claim is made. From a tax perspective, this hybrid design blends the benefits of deferred growth and potential tax-free care coverage.
When the annuity owner dies, the remaining value typically passes to one or more designated beneficiaries. These heirs do not receive a step-up in cost basis as they might with stocks or real estate. This means the contract’s gains are still taxable as ordinary income when withdrawn.
Depending on the terms, a spouse may be able to assume ownership of the annuity and continue its deferral, while non-spouse beneficiaries usually must withdraw funds within a specific period, such as five years.
The timing of those withdrawals determines how quickly the taxable income is recognized.
Estate Planning
Estate planning considerations often focus on how annuity ownership affects both liquidity and inheritance goals.
Because annuities are contracts with named beneficiaries, they generally bypass probate. This can simplify asset transfer, providing heirs with faster access to funds.
However, annuity proceeds are included in the taxable estate for federal estate tax purposes if the owner retained control of the contract at death. Coordinating annuity ownership, beneficiary designations and overall estate strategy can help avoid conflicts between estate liquidity needs and long-term care objectives.
Long-term care annuities can also influence Medicaid eligibility and other means-tested benefits. Since these contracts are considered income-producing assets, they may count toward asset or income limits in certain states. Some policies can be structured to comply with Medicaid Partnership rules. This allows policyholders to protect a portion of their assets if they eventually need Medicaid coverage.
Reviewing the tax implications, ownership structure and beneficiary arrangements with a qualified financial advisor or tax professional can help align a long-term care annuity with broader estate and retirement planning goals.
How Payout Structures Shape the Value of a Long-Term Care Annuity
Long-term care annuities differ widely in how they release funds once care begins.
Some contracts use a reimbursement model, meaning the insurer pays only for documented, qualified expenses. This approach ties the benefit amount directly to invoices from care providers and can restrict the use of funds to specific types of services.
Other contracts offer indemnity or cash benefits, which issue a set monthly amount regardless of the actual bills. Cash models give the owner more flexibility, including the ability to pay family caregivers or use alternative care arrangements that may not qualify under reimbursement rules.
The size of the long-term care benefit also varies across insurers. Many contracts multiply the annuity’s account value by a set factor, such as two or three times the initial premium, to determine the total pool available for care. The multiplier selected can significantly change how long the benefits last in a high-cost setting like a nursing home.
Some riders also cap monthly distributions. This means benefits may extend for many years, but they may still not fully cover large monthly care bills.
Other Considerations
Cost-sharing terms can affect how quickly the annuity provides support. Some contracts impose an elimination period that requires the owner to cover all costs during the initial days of needing care. Others begin payments immediately once eligibility is confirmed. Owners without sizable liquid savings often pay attention to these timelines because even short delays can shift thousands of dollars of early care costs onto personal assets.
Coordination with other coverage, such as Medicare or existing long-term care insurance, may also influence the usefulness of the annuity’s rider. Some contracts reduce payouts when other benefits are available, while others pay the full amount regardless of outside coverage.
This interaction determines how the annuity functions within a broader care-financing plan and whether its benefits supplement or replace other resources.
Bottom Line
A long-term care annuity could be right for you if you think you may need long-term care down the road. Medicare doesn’t pay for nursing care, and while Medicaid can, you might have to spend down your assets before you can get approval for benefits.
An annuity with a long-term care rider can give you regular income, and at the same time prepare you for the worst-case scenario if long-term care is something you eventually end up needing. As with all financial goals, planning is key to long-term care.
Tips for Planning for Long-Term Care
- Consider talking to a financial advisor about your options for preparing for long-term care costs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A related concern is how much regular life insurance you need. SmartAsset’s life insurance calculator will give you a good idea of how much life insurance you should have.
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