Most people don’t think about paying for long-term care (LTC) until the price tag makes it impossible to ignore.
A private nursing home room now costs a median of $129,575 a year, while non-medical caregiver services, which CareScout defines as homemaker and home health aide services, cost $80,080 annually at 44 hours per week, according to CareScout’s 2025 Cost of Care Survey.
Meanwhile, standalone long-term care insurance keeps shrinking, down to roughly 5.8 million policyholders, Milliman’s review of National Association of Insurance Commissioners (NAIC) 2024 data showed.
Fidelity’s Aug. 14, 2026, guidance spotlights a tax-code provision for tax-free swapping of life insurance for hybrid LTC coverage.
How the 1035 exchange converts life insurance into care coverage
IRC Section 1035 permits a tax-free transfer of one life insurance policy to another like-kind contract, Fidelity explained.
The Pension Protection Act of 2006, effective Jan. 1, 2010, expanded that provision to include qualified long-term care contracts under IRC Section 7702B.
Before 2010, policyholders could swap life-to-life or life-to-annuity, but not life-to-LTC. The change opened a direct path from an aging whole-of-life or universal-life policy into a hybrid product combining a reduced death benefit with a long-term care rider.
Jesse Slome, director of the American Association for Long-Term Care Insurance (AALTCI), said most people don’t know this tax-free swap exists.
Few individuals are familiar with Section 1035 of the Internal Revenue Code that allows an individual to repurpose an existing annuity of life insurance policy to one that includes tax-advantaged long-term care benefits.
Qualifying care expenses covered by the new hybrid policy are paid tax-free, Fidelity noted, and the transfer must move directly between carriers.
Unlike an IRA rollover, which permits a 60-day window to redeposit funds, a 1035 exchange must move directly from the original insurer to the new insurer. If the policyholder takes constructive receipt of the funds, the IRS treats the transaction as a taxable surrender.
4 scenarios where the exchange of life insurance for long-term care coverage may apply
Fidelity’s guidance notes the following four conditions.
- The death benefit is no longer needed, and the policy is in jeopardy of lapsing unless premiums rise significantly.
- The existing policy is not performing as expected premiums are rising at increasing rates and may exceed the actual death benefit if held to maturity.
- The gap between the policy’s death benefit and cash value is low, weakening the internal rate of return.
- The policyholder believes they would qualify for LTC insurance based on their current health status and age.
Those conditions sound straightforward, but the exchange carries risks Fidelity’s guidance treats as afterthoughts and comes against a backdrop of a shrinking standalone-LTC market.
A shrinking LTC coverage base meets record long-term care costs
Behind that shrinking base, policy terminations have outpaced new issues by about 127,000 individuals per year over the past decade, Milliman’s review of NAIC data showed.
Meanwhile, roughly 70% of Americans reaching 65 will need some form of LTC, U.S. Department of Health & Human Services data show.
Annual private LTC claims hit $17 billion in 2024, with the average claim rising from about $110,000 in 2015 to $180,000 in 2024, Milliman’s NAIC review indicated.
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Only about 3% of Americans over age 50 have any LTC coverage, Life Insurance Marketing and Research Association (LIMRA) estimates.
This is because premiums remain punishing. A single 60-year-old woman pays roughly $4,450 a year for a $165,000 initial-benefit policy with 3% compound inflation protection, AALTCI’s 2026 price index showed.
Combination life-and-LTC products have responded to that gap, with annuity/LTC sales alone hitting a record in 2024, up more than 50% year-over-year, LIMRA reported.
An estimated $754 billion sat in fixed-rate deferred annuities as of the end of the first quarter of 2025, more than half of it non-qualified, the portion actually eligible for a 1035 exchange into a long-term care contract, LIMRA noted.
Five friction points Fidelity treats as footnotes
Fidelity acknowledged that 1035 exchanges do not fit every situation, and several risks deserve more weight than the firm’s guidance provides.
- Surrender charges on the departing policy: Early surrender charges can significantly reduce the cash value transferred to a new contract, FINRA has warned. Universal and indexed universal policies typically carry declining surrender-charge schedules running 10 to 15 years from issue, according to PineLake Legacy.
- Lost death benefit: A full exchange eliminates the original death benefit, opening a gap for households still relying on survivor protection, FINRA cautioned.
- Fresh contestability period: The new policy has a two-year window during which the insurer can challenge a claim based on application misstatements, FINRA’s alert confirmed.
- Cost of insurance at attained age: The new policy prices mortality at your current age, and for older applicants, that cost difference can erase the benefit, PineLake Legacy warned.
- Health underwriting for the new policy: The new hybrid contract requires medical underwriting at your current age, and declining health since the original policy could mean denial, AALTCI noted.
An old life policy may still have more value than its face suggests
A 1035 exchange can turn an unwanted death benefit into tax-free long-term-care funding, but the economics depend on whether the household still needs the original coverage.
Surrender charges, policy age, cash value, and contract terms can make keeping the existing policy more attractive than exchanging it. Current health also matters because underwriting may limit access to a replacement policy.
A partial exchange can preserve some death benefit, while a life settlement may offer another exit, with the GAO estimating proceeds of 10% to 35% of face value.
Fidelity advises policyholders to consult a financial professional and a tax professional before deciding between keeping, exchanging, or settling an existing policy.
Related: Fidelity highlights tax-free way to fund long-term care
