Annuities and Long-Term Care: How Guaranteed Income Works, the Tax Rules and the Medicaid-Compliant Option

What Is an Annuity?

An annuity is an insurance contract built to turn money into income. You pay the insurance company, and it promises to pay you back on a schedule.

There are two basic phases:

• The accumulation phase. Your money grows tax-deferred inside the annuity.
• The payout phase. The insurer pays you income, monthly or yearly, for a set period or for life. Turning the annuity into income is called annuitizing.

Some annuities skip the first phase and start paying right away. Others grow for years before you ever take a dollar.

Here is the uncomfortable truth. Most people who buy an annuity are thinking about retirement income. Almost nobody is thinking about a nursing home. Then care starts, and the family discovers the annuity they own has surrender charges, a tax bill waiting inside it and rules that change how Medicaid sees it.

An annuity can be a strong part of a care plan. It can also be the most expensive thing to undo.

How an Annuity Works

1. You choose the type. Immediate or deferred. Fixed, indexed or variable. Each works differently.
2. You pay the premium. Usually a single lump sum, sometimes a series of payments. Most annuities do not require medical underwriting. Annuities with a long-term care rider usually do.
3. The money grows tax-deferred at a fixed rate, an index-linked rate or based on investments, depending on the type.
4. You take money out through withdrawals, by annuitizing for guaranteed income or through a rider. Early withdrawals above the free amount can trigger surrender charges.
5. At death, what happens depends on the payout you chose. A life-only payout stops. A period-certain or refund payout sends what is left to your beneficiaries.

Types of Annuities

4 Ways Annuities Can Help Pay for Long-Term Care

1. Guaranteed income to close the monthly gap

Most families have a gap. Social Security and a pension cover some of the bill. Savings cover the rest, until they do not.

An immediate or deferred income annuity can turn part of your savings into a paycheck. A lifetime payout keeps coming no matter how long you live. That is the real promise of an annuity: income you cannot outlive.

But read the payout option carefully. A life-only payout pays the most each month and stops at death, even if that is a year after you buy. A period-certain or cash refund option pays a little less and protects your family.

2. An annuity with a long-term care rider

Some deferred annuities include a long-term care rider. If you need care, the rider pays from a benefit pool that can be two to three times the annuity's value on some policies. If you never need care, the annuity value stays yours or goes to your heirs.

Underwriting is usually simpler than traditional long-term care insurance, which can help people who would be declined elsewhere. Since 2010, under the Pension Protection Act, benefits paid from a qualified long-term care rider on an annuity are generally tax-free.

3. A Medicaid-compliant annuity

This is the strategy families hear about from elder law attorneys, usually after a parent is already in a nursing home.

A Medicaid-compliant annuity turns countable savings into a stream of income. When it meets federal rules, buying it is not treated as a gift, so it does not trigger the look-back penalty. It is most powerful for married couples, because income paid to the spouse at home generally does not count toward the nursing home spouse's eligibility. More on how this works, and the catch, below.

4. A 1035 exchange into long-term care coverage

Since 2010, the Pension Protection Act has allowed a tax-free 1035 exchange of an existing annuity into qualified long-term care coverage, including an annuity with a long-term care rider and many hybrid life/LTC policies. An old annuity sitting untouched can become dedicated care coverage without triggering tax on the gains. You may still need to qualify medically, the money must move directly between insurance companies, and surrender charges on the old annuity may still apply.

The question is not "Do we have an annuity?" The question is "Which way of using it leaves the most for care, and the most for the family?"

What Does Care Cost Compared With Annuity Income?

A guaranteed check feels safe. Care costs put it in perspective. Here are the national medians, based on the 2025 CareScout Cost of Care Survey, compared with an illustrative annuity payment of $1,000 a month.

National median long-term care costs vs. $1,000 a month of annuity income

Source: the 2025 CareScout Cost of Care Survey, as shown on LTCareNav Care Costs by State. Last updated March 2026. The $1,000 payment is an illustration, not a quote.

Now compare that with how long care can last. According to the U.S. Administration for Community Living, someone turning 65 has almost a 70% chance of needing long-term care. Women need it for 3.7 years on average and men for 2.2 years. About 20% will need it for more than five years.

An annuity can make the gap smaller and more predictable. On its own, it rarely closes it. And a fixed payment buys less every year that care costs rise. Costs also vary a lot by state, sometimes two to three times. See the numbers where you live on Care Costs by State, then plug them into the Affordability Calculator to see your care runway: how many months your savings, income and benefits can cover care.

Not sure what level of care is ahead? The Health Trajectory tool projects how care needs may change over time, and the Care Assessment shows what level of care fits today.

Tax Rules You Should Know

• Growth is tax-deferred. You pay no tax on gains while they stay inside the annuity.
• Gains are taxed as ordinary income, not at lower capital gains rates, when they come out.
• Withdrawals from a deferred annuity come from gains first. Every dollar is taxable until the gains are used up (26 U.S.C. § 72).
• Before age 59½, taxable withdrawals generally carry an extra 10% federal tax, with some exceptions.
• Annuitized payments are split. For an annuity bought with after-tax money, part of each payment is a tax-free return of what you paid in, and part is taxable, until your cost is recovered (IRS Publication 575).
• Annuities inside an IRA or 401(k) are generally fully taxable when paid out, and required minimum distribution rules apply.
• No stepped-up basis for heirs. Unlike a home or stocks, an inherited annuity's gains are taxed as income to the beneficiary.
• Long-term care rider benefits from a qualified rider are generally tax-free under the Pension Protection Act.
• 1035 exchanges between annuities, or from an annuity into qualified long-term care coverage, are generally tax-free when the money moves directly between insurers.

Talk with a tax professional before you buy, withdraw, surrender or exchange.

Medicaid-Compliant Annuities: How They Work and the Catch

Long-term care can drain savings fast. When the money runs out, Medicaid is often what pays. To qualify, a person must be at or under the state's asset limit, which is typically $2,000 for an individual. Limits vary by state. See your state's rules in LTCareNav's Medicaid Long-Term Care Guide.

A regular annuity usually counts. If an annuity can be cashed in, Medicaid generally counts its cash surrender value as an asset. Buying an annuity that does not follow the rules can also be treated as a gift. Medicaid reviews transfers made during the look-back period, which is 60 months in most states (CMS). California uses 30 months. A transfer in that window can create a penalty period with no Medicaid coverage.

What makes an annuity Medicaid-compliant

Under the Deficit Reduction Act of 2005 (42 U.S.C. § 1396p), an annuity generally must:

• Be irrevocable. You cannot cancel it or cash it in.
• Be non-assignable. You cannot sell it or transfer it to anyone else.
• Be actuarially sound. It must pay out within the owner's life expectancy.
• Pay in equal amounts. No delayed payments and no balloon payment at the end.
• Name the state as remainder beneficiary. The state must be first in line for any payments left at death, up to what Medicaid paid for care. It can be second only behind a spouse or a minor or disabled child.

The annuity must also be disclosed on the Medicaid application. Some states add their own rules on top of these.

How it protects the spouse at home

This is where Medicaid-compliant annuities do the most good.

When one spouse needs nursing home care, the spouse at home can keep a protected share of the couple's assets, called the Community Spouse Resource Allowance. Everything above that usually has to be spent down. The amount changes every year and depends on your state. See how it works in the Community Spouse Resource Allowance tool in Financial Tools.

A Medicaid-compliant annuity can turn the extra savings into monthly income for the spouse at home. Under federal law, income paid only in the at-home spouse's name generally belongs to that spouse and does not count toward the nursing home spouse's eligibility (42 U.S.C. § 1396r-5). So instead of spending down the savings on care, the at-home spouse keeps them as income.

For a single person, it works differently

For a single person, the annuity income generally goes toward the cost of care each month. Elder law attorneys sometimes pair an annuity with a gift so that part of the savings goes to family while the annuity covers care during the penalty period. This is complex, the rules vary by state and the math has to be exact. In states with an income cap, the extra income may also require a Miller trust (see the Miller Trust tool in Financial Tools).

The catch

Here is the uncomfortable truth. A Medicaid-compliant annuity does not make money disappear. It changes its form.

• The savings become income. That income still counts for Medicaid purposes.
• The state is usually next in line for whatever is left when the annuitant dies.
• It cannot be undone. Once signed, the money is locked in.
• One wrong term, beneficiary or payment schedule can turn it into a penalized transfer.

It is a crisis planning tool, usually bought when care is already needed. Families may also use the Spend-Down Planner in Financial Tools to see when Medicaid comes into the picture, or prepay funeral costs through a funeral trust, which is exempt from Medicaid asset limits (see the Funeral Trust tool in Financial Tools). Talk with an elder law attorney before you buy, cash in or change an annuity. Find one in the LTCareNav Marketplace.

Already Own an Annuity? Check These 6 Things

Pull out the latest statement, or call the insurance company, and find:

• The surrender value today. Not the account value. What you would actually receive if you cashed it in.
• The surrender charge schedule and the date it ends.
• Whether it is qualified or non-qualified, and how much you paid in (your cost basis).
• Riders. Is there a long-term care rider, an income rider or a nursing home waiver that lets you withdraw without surrender charges if you need care?
• Who the owner, annuitant and beneficiaries are.
• Whether it can be annuitized or exchanged into long-term care coverage through a 1035 exchange.

Then enter the surrender value in the Affordability Calculator as part of your liquid assets to see how far it stretches.

Annuities vs. Other Ways to Pay for Care

Compare every option side by side in Financial Tools, including the Annuities, Hybrid Life/LTC Policy and Whole Life Insurance tools. Read more in our guides to hybrid life and long-term care insurance, whole life insurance and long-term care and what long-term care insurance costs.

Pros and Cons of Annuities for Long-Term Care

Advantages

• Guaranteed income you cannot outlive, when you choose a lifetime payout.
• Medicaid-compliant versions can protect assets for the spouse at home by turning savings into income.
• Tax-deferred growth. No tax on gains until they come out.
• Predictable. Fixed annuities do not rise and fall with the market.
• Usually no medical underwriting for income annuities, and simpler underwriting for annuities with long-term care riders.
• State guaranty associations protect annuity benefits if an insurer fails, commonly up to $250,000 per person per insurer, though limits vary by state (NOLHGA).

Considerations

• Surrender charges can be significant. They often last 5 to 10 years and can take a real bite if you need the money early.
• Inflation erodes fixed payments. A payment that covers a share of care today covers less every year. Cost-of-living riders help but lower the starting payment.
• Complex tax treatment on withdrawals. Gains come out first, are taxed as ordinary income and can carry a 10% penalty before 59½.
• Money is locked up. An immediate annuity cannot be cashed in for an emergency.
• No stepped-up basis. Heirs pay income tax on the gains.
• Fees. Variable and indexed annuities can carry rider fees, management fees and caps that limit growth.
• Medicaid planning is unforgiving. A small drafting mistake can turn a Medicaid-compliant annuity into a penalized transfer.

Who an Annuity Fits

An annuity may be worth a closer look if:

• You worry more about running out of money than about leaving an inheritance.
• You have savings that are not earning much and want predictable income.
• You are married and one spouse may need nursing home care, while the other stays at home.
• You own an old annuity that could be exchanged into long-term care coverage.
• You have been declined for long-term care insurance and want another way to plan for care.

It may not be the right fit if:

• You may need the money soon for care, repairs or emergencies.
• The surrender period would outlast your planning window.
• You are counting on the money to pass to heirs at a stepped-up basis.
• You are thinking about a Medicaid-compliant annuity without an elder law attorney.

The question is not "Is an annuity a good product?" The question is "Is it the right tool for our care risk, our timeline and our family?"

How to See If an Annuity Fits Your Care Plan in 5 Steps

1. Find out what you already have. Check any existing annuities for surrender values, surrender charges, riders and nursing home waivers.
2. Project the care. Use the Health Trajectory tool and the Care Assessment to see what level of care may be ahead and for how long.
3. Check your care runway. Look up costs on Care Costs by State, then use the Affordability Calculator to see how far income and savings go and how big your monthly gap is.
4. Model the annuity. Open the Annuities calculator and choose the situation closest to yours (monthly income, liquid assets, home value and age range). The results update instantly. Create a free account to enter your real numbers.
5. Talk before you buy. Take your numbers to a licensed financial professional, a tax professional and, if Medicaid is possible in the next five years, an elder law attorney. Find vetted professionals in the LTCareNav Marketplace.

The calculator gives general estimates to show how an annuity could fit your plan. Actual payments depend on your age, the insurer, interest rates, the payout option and your state. It is a starting point for the conversation, not a quote.

Questions to Ask Before You Buy

• Is this an immediate or deferred annuity? Fixed, indexed or variable?
• What is the guaranteed payment, and what payout option is it based on: life only, period certain or cash refund?
• What are the surrender charges, how long do they last and how much can I withdraw each year for free?
• Is there a nursing home or terminal illness waiver of surrender charges?
• Is there a long-term care rider? How big is the care benefit pool, and how do I qualify?
• Is there an inflation or cost-of-living option? How much does it lower the starting payment?
• What fees and rider charges apply each year?
• How will this annuity be treated for Medicaid in my state?
• If this is meant to be Medicaid-compliant, does it meet every federal and state requirement, in writing?
• What is the insurer's financial strength rating, and what is my state's guaranty association limit?
• Would a 1035 exchange of an annuity I already own serve us better?

Frequently Asked Questions

Guaranteed Income Is Not a Guaranteed Plan

An annuity can give a family something rare in long-term care: a check that keeps coming. It can also lock up money, create a tax bill and leave the state first in line.

The difference is planning. Know what kind of annuity you have, what it costs to change it and how it fits with everything else.

• Model it with the Annuities calculator, and compare it with every other option in Financial Tools.
• Find out how long your money will last with the Affordability Calculator.
• See how much care may be ahead with the Health Trajectory tool.
• Check care costs where you live with Care Costs by State.
• Learn your state's Medicaid rules in the Medicaid Long-Term Care Guide.
• Connect with a vetted professional in the Marketplace.

Not sure where to start? See how every piece fits together in one place to plan for long-term care.

It is free for families.

Sources

• U.S. Administration for Community Living: How Much Care Will You Need?
• Medicare.gov: Long-Term Care
• CMS: Transfer of Assets in the Medicaid Program
• 42 U.S.C. § 1396p: Liens, adjustments and recoveries, and transfers of assets (Cornell LII)
• 42 U.S.C. § 1396r-5: Treatment of income and resources for certain institutionalized spouses (Cornell LII)
• 26 U.S.C. § 72: Annuities; certain proceeds of endowment and life insurance contracts (Cornell LII)
• IRS Publication 575: Pension and Annuity Income
• American Association for Long-Term Care Insurance: 1035 Exchanges for Long-Term Care Insurance
• NOLHGA: How You're Protected
• LTCareNav Medicaid Long-Term Care Guide
• LTCareNav Care Costs by State (the 2025 CareScout Cost of Care Survey, updated March 2026)

LTCareNav provides general educational information, not insurance, investment, legal, tax or financial advice. Annuity features, tax rules and Medicaid rules vary by insurer and state and change over time. Talk with a licensed financial professional, a tax advisor and an elder law attorney about your situation.