By Marc Gilman
📞 Call (800) 927-9326 or (603) 493-1394 | ✉️
If you have savings sitting in an annuity or a CD-like account and you’re worried about long-term care costs down the road, there’s a lesser-known option worth understanding: a long-term care annuity. It’s not the right fit for everyone, but for the right person, it can turn existing savings into a meaningfully larger, tax-advantaged pool of money for care.
Key Takeaways
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A long-term care annuity lets you reposition a lump sum of savings into an account that can pay out 2 to 3 times that amount for qualifying long-term care expenses.
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Unlike traditional LTC insurance, unused funds don’t disappear — they can pass to your beneficiaries if you never need care.
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Qualifying withdrawals can be income tax-free under federal law, but only if the annuity meets specific IRS requirements.
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There are a few different product structures that get lumped under “LTC annuity,” and they work differently — it’s worth knowing which one you’re actually being offered.
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This is a complex, tax-sensitive product. A conversation with both an insurance professional and a tax advisor is worth having before you commit any savings.
How does a long-term care annuity actually work?
At its core, a long-term care annuity takes a lump sum — money you reposition from savings, a CD, or an existing annuity — and links it to a long-term care benefit. If you need qualifying long-term care, the annuity can pay out significantly more than your original deposit, often two to three times the account value, to cover those costs.
If you never need long-term care, the money doesn’t vanish the way an unused traditional LTC insurance premium effectively does. The remaining account value can pass to your beneficiaries, which is the core appeal for people who don’t like the idea of paying for coverage they might never use.
Why can some of these payouts be tax-free?
This is where things get genuinely important to understand, and also where a lot of oversimplified explanations circulate. The tax-free treatment comes from the Pension Protection Act of 2006, which added provisions to the Internal Revenue Code (specifically Section 7702B(b)) allowing distributions from an annuity to be received income tax-free when they’re used for qualifying long-term care expenses — but only if the annuity contains a long-term care rider that meets the IRS’s specific “qualified” requirements, and the annuity was purchased with non-qualified money (regular savings, not funds from an IRA, 401(k), or similar pre-tax retirement account).
In practice, this means:
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The annuity must be structured and worded in a very specific way to meet IRS qualification standards.
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You generally can’t fund one of these with retirement account money and get the same tax treatment.
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Insurance companies report qualifying long-term care benefit payments to the IRS on Form 1099-LTC.
Because the exact tax treatment depends on how a specific contract is structured, this is genuinely a situation where you want both an insurance professional and a tax advisor looking at the actual contract language, not just a general description like this one.
What if I already own an annuity? Can I convert it?
Often, yes. Under Section 1035 of the tax code, you can generally exchange an existing non-qualified annuity directly into a new annuity that includes a qualifying long-term care rider, without triggering income tax on the growth inside your original contract at the time of the exchange. This is a common way people use money they already have set aside, rather than committing new savings.
The exchange has to be done correctly — directly between insurance carriers, not by cashing out and repurchasing — to preserve the tax treatment. This is another area where getting professional guidance before you act matters more than usual.
There isn’t just one kind of “LTC annuity” — here are the main variations
This term gets used loosely, but there are a few distinct product structures:
A dedicated long-term care annuity is built specifically to fund care. It’s designed to multiply your deposit for qualifying LTC expenses, with less emphasis on producing retirement income along the way.
An income annuity with a long-term care rider is primarily a retirement income product — the kind that pays you a steady income stream in retirement — with an LTC rider added on that can temporarily boost your income (often for a limited number of years) if you need care. The LTC benefit here is a secondary feature, not the main purpose of the contract.
A deferred annuity with a long-term care waiver doesn’t multiply your money at all. It simply waives the early-withdrawal penalty (surrender charge) if you need to access your annuity funds early because of a qualifying long-term care event. It’s the most limited version of the three, but it’s also the simplest and adds no ongoing cost.
Knowing which of these you’re actually being shown matters, because they solve different problems and are priced very differently.
How do you actually qualify to receive benefits?
An LTC annuity doesn’t pay out just because you reach a certain age or decide you want the money — you have to meet the same kind of “benefit trigger” that applies to qualified long-term care insurance generally. Under the federal tax code, you’re typically considered eligible if a licensed health care practitioner certifies that you either:
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Need substantial assistance with at least two Activities of Daily Living (bathing, dressing, eating, toileting, transferring, or maintaining continence), or
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Require substantial supervision due to a severe cognitive impairment, such as dementia
This is the same standard used across most tax-qualified long-term care products, not something unique to annuities — but it’s worth knowing going in, since it means the money isn’t available on demand simply because you decide you’d like extra help around the house. It has to be a genuine, certified long-term care need.
To put the potential cost gap in perspective: national median costs for long-term care are substantial and climbing. A recent Cost of Care Survey put the median cost of a home health aide at roughly $6,292 a month, assisted living at $5,900 a month, and a private nursing home room at $9,277 a month. Those are exactly the kind of expenses an LTC annuity’s multiplied payout is designed to help absorb.
Who is this actually a good fit for?
A long-term care annuity tends to make the most sense for people who:
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Have a lump sum of savings, often in the tens of thousands of dollars or more, that they’re comfortable repositioning
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Want long-term care protection but don’t want to pay ongoing premiums the way traditional LTC insurance requires
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Like the idea that unused funds go to their heirs instead of the insurance company
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Are in reasonably good health, since these products still generally involve a phone interview and medical background check, even if it’s typically a simpler underwriting process than traditional LTC insurance
It tends to make less sense for people who have little in savings to reposition, who already need care now, or who are older than the age ranges most carriers will issue new policies for — some carriers stop issuing new LTC annuity contracts somewhere in a person’s early-to-mid 80s, though this varies by carrier.
It’s also worth weighing against the alternatives directly. Compared to traditional long-term care insurance, an LTC annuity trades ongoing premiums for a single lump-sum commitment, and swaps “use it or lose it” for a guarantee that unused money isn’t wasted — but it generally requires more capital upfront than a traditional policy’s annual premium would. Compared to a hybrid life insurance policy with an LTC rider, the mechanics are similar in spirit (leverage a lump sum, guarantee a benefit either way), but the underlying vehicle — annuity versus life insurance — changes the tax treatment, underwriting process, and how the death benefit works if you don’t end up needing care. None of these is categorically better; the right one depends on your health, your assets, and which trade-offs matter most to you.
What To Do Next
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If you have an existing annuity or a lump sum you’re not actively using, it’s worth asking whether a long-term care annuity or a 1035 exchange makes sense for your situation.
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Get the actual contract’s tax qualification confirmed in writing — don’t rely on a general assumption that “annuities with LTC riders are tax-free.” Some are; some aren’t, depending on how they’re structured.
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Loop in a tax professional before committing savings, particularly if you’re considering a 1035 exchange.
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Compare this option against traditional LTC insurance and hybrid life/LTC policies — the right fit depends on your specific savings, health, and whether ongoing premiums or a lump-sum repositioning makes more sense for you.
📞 Call (800) 927-9326 or (603) 493-1394, or email — we’re happy to walk through whether a long-term care annuity fits your situation alongside the other ways to plan for long-term care costs.
Sources:
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CareScout Cost of Care Survey, July–December 2024
