Americans have amassed over $2 Trillion of assets in annuities, and most are intended to grow tax-deferred until needed to supplement retirement income or Social Security.  However, surveys^{^} show many of these annuities will be left untapped and continue to grow, usually until the annuity owner passes away.   Those same surveys also indicate that as annuity owners age, they often view the assets as an “emergency fund” to cover catastrophic illness or Long-Term Care expenses during retirement.    Simply put, if the original goal for an annuity has changed over time, it may be time to consider leveraging the power of The Pension Protection Act (PPA).  

Congress enacted the PPA in 2006; however, the provisions for annuities, which consumers and advisors are leveraging today, didn’t become effective until 2010.   Every situation is unique*, but these provisions generally allow an annuity owner to (1) upgrade an existing annuity to a PPA-compliant annuity TAX-FREE and (2) take TAX-FREE distributions from the new annuity to cover qualifying Long-Term Care expenses in the future.

Real-World Implications

The best way to see the power of the PPA is to look at a real-life example.  Let’s look at Sally Saver, who deposited $100,000 into a fixed-rate, tax-deferred annuity 15 years ago before marrying her current husband, Sam.  That annuity is now worth $200,000, and she is beginning to see friends and relatives need Long-Term Care and knows that most of those expenses are excluded by Medicare.   As such, the goal of the annuity has changed, and she now intends for it to help cover the cost of future expenses for “Healthcare in Retirement” for the couple. 

Using the power of the Pension Protection Act and “upgrading” to a PPA-compliant solution, she can now leverage her $200,000 annuity into $600,000 of Long-Term Care benefits AND include her husband on the plan!  She now has an excellent way to “upgrade” her annuity to help mitigate the risk associated with future Long-Term Care needs.   This strategy is even better for tax planning purposes!

Turn Taxable Gains Into Tax-Free Benefits!! 

The original investment of $100,000 (her basis) into the annuity has grown to $200,000, so ANY withdrawals from the old annuity would be subject to LIFO (last-in, first-out) accounting rules, and taxable earnings would come out first to pay for future Long-Term Care expenses, resulting in reportable income in the year taken.  

However, by “upgrading” to a PPA-Compliant solution, the result would be TAX-FREE distributions of the total $600,000 of Long-Term Care benefits available to both spouses rather than taxable distributions of just the $200,000 of accumulated cash value.   This is an excellent example of using the tax code to their advantage, where the couple can implement a substantial Long-Term Care plan with zero out-of-pocket cost simply by repositioning or reallocating the existing annuity....