Pros and Cons of Long-Term Care Annuities

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 ¹ . 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. A rider is essentially an add-on you can include when purchasing an annuity that offers extra features or benefits.

Here’s how it works: 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. Payments can be made to you monthly or as a lump sum. Your annuity company can either give you funds to use as needed or reimburse you for expenses you’ve already paid for.

To activate the long-term care rider and begin receiving benefits, you’ll have to 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 in home or in a nursing facility.

Annuities grow with interest and a long-term care annuity can either be fixed or variable. 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. A variable annuity tends to be riskier. But, if the underlying investments perform well, it offers the opportunity to earn 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, it provides the best of both worlds. It’s essentially a regular annuity payment you can rely on for retirement, with the long-term care rider to pay for care costs, if necessary.

There’s another advantage, too, especially if you have an existing health issue. You might 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 such as 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 also be a more budget-friendly option. Long-term care insurance premiums are dependent on several factors. These include your home state, age, gender, whether you need coverage for yourself or a spouse as well, how long you want the policy to pay out, and the dollar amount of benefits you’d like the policy to pay. 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 it comes to an annuity with a long-term care rider. For one thing, you may be expected to make a large upfront premium payment to get covered. And the more likely you are to need long-term care, based on the insurance company’s risk assessment, the higher that premium might be.

Paying it could also be challenging if you don’t have a lot of liquid cash reserves to tap into. You might have to sell off some of your investments. Or withdraw money from a 401(k) or IRA to cover the premium payment, which could trigger a tax penalty.

Speaking of taxes, it’s important to mention that annuity payments are taxable. The 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 wouldn’t be 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 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 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 expenses in retirement.

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 to the extent 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, meaning 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, which can simplify asset transfer and provide 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, allowing 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.

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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