How to Take Tax-Free Annuity Withdrawals for Long-Term Care

Withdrawals from a non-qualified annuity that carries a qualified long-term care insurance rider can come out completely free of federal income tax when they are used to pay for care and the insured person meets the federal definition of chronically ill. This is the rule that makes tax-free annuity withdrawals for long-term care possible, and it was added to the tax code by Section 844 of the Pension Protection Act of 2006 as 26 U.S.C. § 72(e)(11).¹ For 2026, the tax-free benefit is capped at $430 per day unless your actual qualified care costs are higher.²

Ordinarily, money pulled from a deferred annuity comes out earnings-first and is taxed as ordinary income. The § 72(e)(11) carve-out sidesteps that by treating charges deducted from the annuity’s cash value to pay for qualified long-term care coverage as outside your gross income. The tradeoff: those charges also reduce your cost basis in the contract, though the basis is never pushed below zero.³

What Kind of Annuity You Need

Two things have to be true about the contract. First, it must be a non-qualified annuity, meaning one bought with after-tax dollars outside of an IRA, 401(k), or other pre-tax retirement account. Annuities held inside a traditional IRA generate fully taxable distributions no matter what the money pays for, so the § 72(e)(11) exclusion adds nothing.

Second, the annuity must include a qualified long-term care insurance rider, or be a combination “hybrid” annuity built around one. A plain deferred annuity without the rider does not qualify. In a typical hybrid, a periodic charge is deducted from your account value to fund the long-term care coverage. When a qualifying care event occurs, the annuity pays out its account value for care first; once that value is exhausted, the separate long-term care insurance continues the benefit stream. The long-term care component itself has to satisfy 26 U.S.C. § 7702B.⁴

If Your Current Annuity Has No LTC Rider

You are not stuck. The Pension Protection Act also expanded 26 U.S.C. § 1035 to permit tax-free exchanges from an annuity contract into a qualified long-term care insurance contract without recognizing gain.⁵ Partial exchanges are allowed too: a portion of an existing annuity’s cash value can be transferred directly to a qualified long-term care contract while the rest stays put.⁶

The transfer has to move directly between insurers. If you take a check from the old carrier and then buy a new contract with it, the IRS treats it as a taxable distribution followed by a purchase, not an exchange.

Meeting the Chronically Ill Standard

Tax-free treatment only applies while the insured person qualifies as chronically ill under federal rules. There are two paths.

The functional path requires a licensed health care practitioner to certify that you cannot perform at least two of six activities of daily living without substantial assistance from another person, and that the limitation is expected to last at least 90 days.⁴ The six activities are:

Eating
Toileting
Transferring (for example, moving between a bed and a chair)
Bathing
Dressing
Continence

A qualifying contract must weigh at least five of these six when applying the standard.

The cognitive path is separate. If you need substantial supervision to protect your health and safety because of severe cognitive impairment, such as Alzheimer’s disease or dementia, that alone qualifies, regardless of how many activities of daily living you can still handle.⁷

Certification is not one and done. The statute requires a licensed practitioner to confirm chronically ill status within the preceding 12-month period. If the certification lapses, benefits paid during the gap can lose their tax-free treatment.

The 2026 Daily Cap and When Excess Becomes Taxable

The per diem limitation for 2026 is $430 per day, adjusted annually for inflation.² The tax-free amount for any period is the greater of that daily cap or your actual qualified long-term care expenses for the period, reduced by reimbursements from other insurance.⁸

In practice, if benefits stay at or under $430 per day, nothing is taxable regardless of what care actually cost. If benefits exceed $430 per day, they are still tax-free so long as your real care costs also exceed that daily figure. Benefits become taxable only when they outrun both the $430 threshold and your actual expenses.

That distinction matters most for indemnity, or per diem, policies that pay a flat daily amount independent of what you spend. A contract paying $500 a day against nursing home costs of $450 a day is still fully tax-free, because the actual cost ($450) is above the $430 cap and the benefit does not exceed actual cost by enough to matter. Reimbursement-style policies, which pay only actual qualifying costs, rarely trigger a tax bill because benefits are tied to expenses by design. If the same insured person holds more than one long-term care contract, the IRS aggregates all benefits when applying the daily cap.

Filing the Claim

The claim starts with the insurance carrier’s long-term care benefit request form, which asks for policy and identification details. The document that carries the most weight is the plan of care: a written care plan prepared by a licensed health care practitioner that identifies the specific long-term care services you need.⁹ You will also submit the practitioner’s formal certification of chronically ill status and details on the care provider, including name, address, tax identification number, and often a license number for home care.

Most carriers accept claims through a secure portal, certified mail, or fax. Once the claim is on file, an elimination period runs before payments begin, typically 30 to 90 days depending on the contract. You cover care costs yourself during that window.

A denial is not necessarily the end. The denial letter should identify the specific requirement the carrier says was not met, and denials often turn on thin documentation of chronically ill status or a care plan that does not clearly describe qualifying services. Supplement the file with updated certifications and resubmit. Appeal timelines are set by the contract and state insurance regulations, so check both.

Reporting the Benefits on Your Return

Tax-free does not mean paperwork-free. The insurance company issues Form 1099-LTC reporting all long-term care benefits paid during the year, with copies going to you and the IRS.⁷

If benefits were paid on a per diem or other periodic basis, you must complete Section C of Form 8853 with your return. That is where the math sits: the form calculates whether any portion of the benefits ran past both the $430 daily cap and your actual expenses, and therefore became taxable. It offers two ways to define your long-term care period, the contract period method and the equal payment rate method.¹⁰

Reimbursement-style policies that pay only actual costs generally do not need Form 8853, because benefits cannot exceed expenses. If per diem benefits and reimbursement benefits both show up in the same year, both go on the form and the combined per diem cap applies.

Hold on to receipts for qualified care, provider invoices, and every practitioner certification. If your exclusion depends on claiming that actual expenses exceeded $430 a day, the IRS may ask you to prove it.

Medicaid Is a Separate Question

If Medicaid may eventually pay for your care, an annuity’s tax treatment is only part of the picture. A non-qualified annuity generally counts as an asset for Medicaid eligibility, and annuity income payments count toward Medicaid’s income limit. Converting a lump-sum annuity into an income stream can address the asset test but may push monthly income above what Medicaid allows. Medicaid also runs a look-back period, typically five years, during which certain annuity transactions can trigger a penalty period of ineligibility. To avoid a look-back penalty, an annuity generally has to be irrevocable, non-transferable, actuarially sound, and name the state as a remainder beneficiary. The rules vary enough by state that an elder law attorney is worth consulting before making annuity moves with Medicaid on the horizon.

1
Congress.gov. H.R.4 – Pension Protection Act of 2006
2
Internal Revenue Service. Revenue Procedure 2025-32
3
Office of the Law Revision Counsel. 26 U.S. Code 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
4
Office of the Law Revision Counsel. 26 U.S. Code 7702B – Treatment of Qualified Long-Term Care Insurance
5
Office of the Law Revision Counsel. 26 U.S. Code 1035 – Certain Exchanges of Insurance Policies
6
Internal Revenue Service. IRS Notice 2011-68 – Annuity Contracts With Long-Term Care Insurance Riders
7
Internal Revenue Service. Instructions for Form 1099-LTC
8
Office of the Law Revision Counsel. 26 U.S. Code 7702B – Treatment of Qualified Long-Term Care Insurance
9
Federal Long Term Care Insurance Program. Long Term Care Insurance
10
Internal Revenue Service. Instructions for Form 8853