Long-term care is expensive. Whether it’s a nursing home or other assisted-living facility, or home-based services, the extended duration and continuous care result in quickly mounting costs.
Private nursing homes average around $80,000 per year, and even home-based care comes in at around $40,000.(1) These cost levels can rapidly deplete a retiree’s entire savings, leaving Medicaid as the only option and no wealth to pass on to loved ones.
So, preparing for the potentially enormous expense is a priority in many retirement plans.
Traditional Long-Term Care Insurance
Historically, the best way to prepare for the potential future costs of long-term care was through long-term care insurance (“LTCI”).
Long Term Care Insurance is a fairly straight-forward insurance policy under which the policyholder makes regular premium payments to the insurer and, in exchange, the insurer pays for some or all costs of long-term care if the policyholder ever ends up needing it.
By covering what can end up being hundreds of thousands of dollars in bills, LTCI prevents an insured’s nest egg from being wiped out – whether directly through provider payments or through an asset “spend-down” to qualify for Medicaid assistance.
Long term care insurance has been a saving grace for many people, and many still have the coverage, often through their employers.
According to Forbes, 25% of employed Baby Boomers had LTCI policies as of 2014. (2) But that number has been steadily decreasing for a couple reasons.
First, many insurers are phasing out LTCI and are no longer issuing new policies.
And, second, due to the high-costs of long-term care and ever-increasing longevity, Long term care insurance premiums are quite high, particularly for policyholders who don’t obtain coverage until later in life.
Due to the high premiums, more and more consumers – even those who recognize the need to prepare for long-term care costs – have decided against LTCI.
Utility of LTCi
It’s not that LTCI isn’t useful. If you end up needing nursing-home care, LTCI can be one of the best financial decisions you ever made.
The problem is that the prospect of paying high premiums for a policy that might never pay out is unappealing to many people.
Not everyone ultimately needs long-term care, and so not every LTCI policy proves its value. But enough do that the premiums have to be fairly high.
In the face of this dilemma, insurers have introduced an alternative, asset-based approach to protecting against future long-term care costs.
Over the last few years, asset-based long-term care has rapidly grown in popularity, surpassing traditional LTCI among new purchasers.
What is Asset-Based Long-Term Care?
Asset-based long-term care (“ABLTC”) is an innovative insurance strategy that provides coverage for long-term care expenses without running the risk of “wasting” premiums if you don’t need long-term care.
The beauty of ABLTC is that, if you don’t need long-term care, the annuity or whole-life policy retains its value and pays out to your designated beneficiary. And many people who might not qualify for traditional LTCI due to preexisting conditions may still be able to obtain coverage.
LTC coverage and Death Benefit
If an asset based long term care plan is triggered, funds from the whole-life policy or annuity are applied toward long-term care expenses. Any value that’s left over gets paid out to heirs as a death benefit.
As with just about any insurance product, there are coverage caps, but the caps are usually significantly higher than the present cash value of the asset at the time the policy is issued.
So, you have a lot more money for long-term care expenses than if you just surrendered an existing whole-life policy and earmarked the cash for nursing home costs.
Because the asset used for the plan retains its independent value, ABLTC plans are sometimes referred to as “combination plans” or “linked-benefit plans,” depending on the specific insurer and product.
How do Asset-Based Long-Term Care Plans Work?
Assert based long term care insurance plans function similarly to regular whole life insurance policies or annuities, but with the added benefit of long-term care coverage.
After applying for the coverage and going through underwriting, you make premium payments to the insurer.
In many cases, the premium is paid via a single, up-front, lump-sum payment.
The funds can come from liquidating other investments or through a tax-free 1035 exchange that converts an existing whole-life policy or annuity into an ABLTC policy.
Insurers also offer limited pay whole life insurance coverage with premium payments extended over a defined period, usually five to ten years, though a larger down payment may be required upfront.
IRA or 401K
For recent retirees, a popular approach is to fund an ABLTC plan using cash from an IRA or 401k. Because money from the retirement account is pre-tax, the transfer to pay the premium is a taxable event. However, the withdrawals can be organized over several years to mitigate income tax liability.
If more than a single premium is involved, future premium payment amounts are almost always guaranteed to stay the same for the life of the plan.
Likewise, the long-term care benefits are usually guaranteed for life.
And, as with a regular whole-life policy or an annuity, the policy’s value earns guaranteed growth.
So, if the long-term care benefits are never tapped, the money is not just sitting there doing nothing – it’s earning interest that your beneficiary receives on the back end.
Most ABLTC policies allow for a full premium refund should you choose to surrender the plan.
That is, if you decide after a few years that you don’t want an ABLTC plan anymore, you can get back all of the money you put into it.
Of course, if you do so, you will no longer have the long-term care coverage or a death benefit.
Long-term care triggering events can vary by policy, but benefits commonly kick in if the insured needs assistance with two or more activities of daily living (e.g., eating, dressing, bathing).
Some, but not all, policies from the various long term care insurance companies have a waiting period of around thirty or sixty days from the time a healthcare provider verifies eligibility until benefit payments commence.
Once triggered, benefits can be paid to the long-term care provider directly, as reimbursements for bills and receipts, or in the form of a check to the insured – depending on the policy language. However paid, benefits are typically subject to a predefined monthly benefit cap.
Some policies only pay expenses from licensed healthcare providers, while some permit expenses for care provided by an unlicensed family member.
So, if an adult son or daughter takes time off work to provide assistance, the policy can help make up the difference in missed pay.
Income Tax Free
As long as used for long-term care expenses, ABLTC plan distributions are not subject to income tax.
The Pension Protection Act of 2006, which provides for tax-free distributions from annuities or life insurance policies when applied to long-term care expenses, has played a large role in the recent surge in popularity of ABLTC plans.
Various customizations and riders are available to tailor ABLTC plans to a policyholder’s specific needs, including dual plans that cover couples within a single policy.
Extension of coverage riders, which provide coverage for an additional period after initial benefits run out, are among the most common riders.
So, for instance, an ABLTC plan linked to a whole life policy could continue paying long-term care benefits even after the policy’s death benefit had been exhausted.
Or, a catastrophic illness rider can allow for extended or lifetime benefits in the event of certain severe diagnoses, such as Alzheimer’s.
Riders require additional premiums, and not all riders are offered by all insurers.
Asset-Based Long-Term Care with Whole Life Insurance
There are two basic approaches to linking ABLTC with whole life insurance. One way is to get a policy that comes with a long-term care rider, which, if triggered, accelerates the policy’s death benefit to pay for long-term care expenses.
If you have a policy with a $100,000 death benefit and need long-term care, the insurance company will pay the expenses and deduct the payments from the eventual death benefit.
Long-term care riders usually have a monthly cap, expressed as a percentage of the death benefit.
For instance, if a policy has a $100,000 death benefit and a 4% monthly cap, it would pay out up to $4,000 per month for long-term care expenses.
The other approach is what is known as a “hybrid” plan. This is a single policy providing life insurance and long-term care coverage.
The two benefits exist separately except that they are both paid from the same pool of money.
In practice, the two approaches to ABLTC in conjunction with whole life work similarly, though hybrid policies do not necessarily have to have the same coverage limits for long-term care and death benefits.
Thus, a policy might cover long-term care in an amount greater or lesser than its death benefit, though the eventual death benefit is reduced by the amount of any distributions.
Whole life policies including asset based long term care require premiums and underwriting similar to standard whole-life policies.
And, like any life insurance policy, younger, healthier insureds are generally eligible for lower premiums (or greater coverage for the same premium).
As an example, let’s say an insured (we’ll call him “Randy”) is fifty years old, in good health, and has an existing whole life policy with a cash value of $100,000. Randy decides that he needs long-term care coverage, but instead of purchasing a traditional LTCI policy, he opts to convert his existing policy into a hybrid policy through a 1035 exchange, resulting in no current tax liability on the policy growth.
Just in case his long-term care needs end up exceeding the policy’s value, Randy purchases a long-term care extension providing an additional pool of funds if necessary. The extension requires additional premium payments, which Randy elects to spread out over ten years at the insurer’s guaranteed rate.
Randy’s new policy comes with a $300,000 death benefit and a guaranteed growth rate of 1.5%.
If Randy ends up needing long-term care, he can tap the policy value, including the growth, plus the amount of the extension if necessary. The long-term care distributions will be tax-free under the Pension Protection Act.
Any remainder will be paid to his designated beneficiary upon his death.
If he doesn’t need long-term care at all, the beneficiary will receive the entire death benefit. Either way, the death benefit will not be taxable income to the beneficiary.
Asset-Based Long-Term Care with an Annuity
Although ABLTC plans are more common with whole life policies, use of the strategy with annuities has been gaining in popularity.
Alternatively, an existing annuity can be converted into a whole-life policy with long-term care benefits via a 1035 exchange. The exchange avoids the income tax that would otherwise be owed on the annuity’s growth – unless the growth is not ultimately spent on long-term care expenses.
An ABLTC annuity is a deferred annuity, which means that it doesn’t start paying out right away.
Instead, after you make a lump-sum payment to the insurance company to purchase the annuity, it stays in the “accumulation phase” (the period during which an annuity earns interest before paying out) until either the long-term care benefits are triggered or you opt for annuitization.
Because some of the growth is covering underwriting costs, the rate is usually a little less than what you would otherwise expect from a deferred annuity.
If triggered, the annuity pays out each month for long-term care, up to an overall coverage maximum, usually around 200 – 400% of the starting value of the annuity itself, depending on factors such as age, health, and monthly caps.
As with whole life, benefit distributions reduce the annuity’s value and also count against the coverage cap.
Cash out or Annuitization
If you end up deciding you don’t need long-term care coverage and any minimum deferral period has concluded, you can either cash out the annuity for its current value or elect annuitization and receive regular payments from the insurance company, as with a lifetime annuity.
If you keep the coverage but don’t use it, your heirs will be able to inherit the annuity’s accrued value.
Individual ABLTC annuities vary considerably from company to company and product to product.
Some make regular payments upon maturity, like a standard lifetime annuity, and increase the size of the payments if long-term care benefits are triggered.
Others cover long-term care only while annuitization is deferred. Annuities also vary in the extent to which the remainder can be inherited if benefits are triggered but not exhausted.
Commonly, survivors can inherit any of the annuity’s cash value remaining after deducting long-term care payments.
By way of example, say Sharon uses $100,000 in retirement funds to purchase an ABLTC deferred annuity with a $300,000 coverage cap. The $100,000 principal grows at 2.0% for ten years until benefits are triggered. Then, the annuity pays out $4,000 per month for long-term care expenses.
After a year, Sharon passes away. Because the total long-term care benefits did not reach the annuity’s cash value, Sharon’s heirs can inherit the remaining cash value, including growth.
On the other hand, had Sharon received long-term care for five years, the annuity would have paid out $240,000 for long-term care – considerably exceeding the cash value but still within the coverage cap.
In the latter scenario, Sharon’s heirs would not inherit the annuity because no cash value remained.
Asset-Based Long-Term Care Products
Insurers like State Life Insurance Company have responded to the increased demand for asset-based long-term care by offering new approaches to life insurance and annuities that consider the extended long-term care needs of today’s population.
State Life’s innovative Care Solutions line of ABLTC products is designed for individuals who want to allocate adequate resources for care while preserving a legacy for their heirs.
Asset-Care, which is available as a single policy covering two persons, is ABLTC whole life insurance with a guaranteed death benefit that can be accelerated toward long-term care costs.
Annuity Care allows tax-advantaged application of annuity value toward long-term care costs and comes with an extended-benefits option with guaranteed premiums.
Immediate Care is a medically-underwritten SPIA providing monthly payments guaranteed for life to help cover long-term care costs.
And, Legacy Care allows forward-looking consumers to safely and securely grow their wealth without sacrificing the need to fund future long-term care.
Over the past ten years or so, asset-based long-term care plans have been a game changer when it comes to funding future assisted living expenses.
If you are considering LTCI options, please give us a call today and speak to an experienced professional who can explain to you the different options available, based on your unique needs, goals and objectives.