The murky tax status of LTC policies

Advisors need to make clear to clients that the tax treatment of payments from long-term care insurance policies may change


The uncertain tax status of long-term care insurance policies means advisors need to take extra care in explaining the implications to clients, says Susan St. Amand, president of Ottawa-based Sirius Financial Services.

“Advisors should be — and, I believe, most are — telling their clients that the tax treatment may at some point be changed,” she says. “I say to my clients that, although there is nothing in the Income Tax Act that sets out what LTC insurance is, Finance Canada and Canada Revenue Agency may see it differently.”

The tax treatment of benefits provided by LTC policies is unclear, mainly because the federal Income Tax Act does not specifically refer to it, as LTC has been actively marketed only in recent years.

St. Amand tells clients that insurance advisors hope that Ottawa will eventually decide to treat individual LTC policies as accident and sickness benefits, which are non-taxable.
“However,” she says, “at this time, I can’t guarantee to them that if they put in a claim in
20 years that the benefits will be tax-free.”

LTC payments are generally dispensed upon serious medical trauma. Therefore, the industry’s argument against taxing them is that, because benefit payments from other accident and sickness insurance products are tax-free, LTC payments should be, too.

Refund of premium

Another tax issue arises from the “refund of premium on death” feature found in some LTC policies. The question is whether the CRA could view the LTC policy as a life insurance policy for income tax purposes because of the ROP on death
“The concern is not that the life insurance death benefit per se would be taxable, but rather that the existence of a death benefit would cause the policy to be considered a life insurance policy for tax purposes. The problem is a life insurance policy normally has an accumulating fund, an adjusted cost base and a defined means of calculating the net cost of pure insurance,” says Ted Ballantyne, director of advanced tax policy at the Ottawa-based Conference for Advanced Life Underwriting. He adds that those mechanisms don’t apply to an LTC policy.

The Toronto-based Canadian Life and Health Insurance Association and CALU argue that the ROP feature only provides a refund of premiums paid up until the date of death, and they are lobbying Ottawa to ensure that the CRA and Finance Canada do not eventually deem the ROP a death benefit. That interpretation could potentially affect the tax status of such policies, leading to the possibility that the income tax rules applicable to life insurance would apply.

Life insurance benefit payouts are not taxed, but income generated by premiums may be taxed upon their return to the policyholder under a set of rules within the act.

This is unlikely to become an issue in Quebec because the Quebec Insurance Act allows for having what it terms “ancillary” — or secondary — benefits that do not affect the primary nature of the contract, in this case the potential provision of an LTC payout. But, in common-law provinces, there is no provision for ancillary or secondary benefits; provincial insurance authorities could therefore deem the ROP clause a death benefit.

The outlook for a quick, definitive resolution is not promising, given that the federal government has other issues on the front burner, says Ballantyne. “We’re dealing with it at the senior staff level at both the Department of Finance and the CRA,” he says.

Tax issues involving LTC as well as critical illness insurance formed the core of a paper entitled Analysis and Discussion Regarding the Taxation of Critical Illness and Long-Term Care Insurance in Canada, prepared by the CLHIA and CALU and forwarded to Finance Canada and the CRA in March 2004. This report focuses on stand-alone individual CI and LTC policies, and does not deal with group policies. (See www.calu.com/website/publications_.html)

The federal government’s history of grandfathering existing tax situations when legislating changes offers only limited assurance that benefits and ROP provisions in existing policies would be untouched if the government decides to tax them, says Terry Zavitz, president of London, Ont.-based Terry Zavitz Insurance Inc.

She says the absence of tax rules for LTC policies means the need for grandfathering would require new legislation to crystallize the interpretation of existing contracts.

@page_break@After the tax implications of individual policies have been resolved, the industry will seek answers to the tax treatment of group plans. The answers won’t necessarily be same, because group plans have additional factors — for example, situations in which an employer pays all or part of the group premium. IE