By Brian M. Johnson, MBA, CLTC
Many clients have qualified assets they intend to use for retirement income. However, there is one risk that could potentially jeopardize even the most well thought out plan—the need for long-term care or extended healthcare.
Long-term care is defined as needing assistance or supervision with everyday activities of daily living or ADL’s. A long-term care event is generally not cure oriented and the need for services, whether in home or a facility, is expected to last longer than 100 days. This type of care of referred to as custodial care, and a reason why traditional health insurance, Medicare and/or Medicare Advantage plans don’t cover it. Our default plan includes trying to qualify for Medicaid, which is a financially means tested program, which typically covers a nursing home, zero assisted living and limited home care or to use our own assets and income.
A hybrid long-term care policy is another popular way to address the risk. It’s a type of permanent life insurance policy which offers three core benefits: An income tax-free life insurance death benefit long-term care services aren’t needed, cash indemnity benefits to pay for home care, assisted living and/or skilled nursing and a return of premium rider, which allows the insured to surrender the policy and receive either all or a portion of their premiums back with no penalty or charges.
Unlike a traditional long-term care policy, policy premiums are guaranteed and can never increase and benefits for are paid in cash to the insured, meaning the insured can use the funds however he/she sees fit, whether it’s to offset other bills, pay a family member or licensed providers. It’s an asset allocation approach to financing long-term care needs.
A draw back of the policy is that premiums tend to be higher than that of a traditional policy because of the fact that’s it’s filed a permanent life insurance policy and the premium payment period is condensed to either one, single payment or over 5, 10 or 20 years. Typically, clients are using safe money assets like money market accounts or certificates of deposit to fund the policy.
However, some people may not have the liquid assets to cover premiums but may have accumulated sizeable balances in their qualified retirement plans or IRA’s. This strategy carves out a portion of the client’s qualified assets to purchase an IRA annuity. The taxable distribution creates a premium to purchase tax-free LTC coverage that can help pay for potential LTC needs that could occur in the future. Let’s look at and example where all values are hypothetical and subject to underwriting approval.
Jessica—60 years old, in good health and married—is concerned about LTC after seeing how those expenses impacted her parent’s retirement plans. Allyson’s parents thought they were well set, and were until care expenses started to deplete their savings.
Jessica’s father passed away first, but his LTC expenses left her mother’s life-style impacted – leaving no extra money for the travel she had hoped to enjoy with friends in her golden years. Eventually, her mother had five years of LTC expenses of her own, and the money she was hoping to leave to her family was gone. Jessica’s goal is to have a plan that includes LTC coverage.
The strategy: Jessica decides a hybrid long-term car policy would best fit her needs. Once claims qualifications are met, full LTC benefits are available — without the need to submit bills or receipts. She likes the flexibility and simplicity the cash indemnity benefits provide. Since there are no restrictions on how LTC benefits can be used, Jessica can use her benefits to pay for a variety of needs that may not be covered by a reimbursement LTC policy, including using her benefits to pay for informal care from an immediate family member or hiring less expensive and potentially more accessible unlicensed caregivers.
Jessica will carve out 10 percent of her portfolio ($100,000) and transfer it from her 401K plan into a IRA Single Premium Immediate Annuity (SPIA)—which will be set up with a guaranteed 10-year term certain payout. Her annual distribution of $11,000 will start immediately. Distributions will be fully taxable as ordinary income because it is coming from an IRA annuity.
The entire $11,00 annual distribution from the SPIA will purchase a Hybrid LTC policy with a 10-year annual premium schedule. Jessica has decided to pay taxes due on the distribution out of pocket to preserve more funds for the premium payments.
Premiums are guaranteed to remain the same and the policy will be fully paid up in 10 years. Her annual distribution will be leveraged into a total of $417,836 of tax-free long-term care benefits; and should Jessica pass away without needing her LTC benefits, there is a death benefit of $139,279 that will be paid tax-free to her beneficiaries. If she passes away before all term-certain annuity payments have been received, any remaining payments will also be paid to beneficiaries (those funds will be taxed at the beneficiary’s ordinary income tax rate).
Should Jessica need to use her LTC benefits, and upon claims qualifications being met, Jessica will receive a monthly tax-free LTC benefit of $6,000 for six years. Even if all the LTC benefits are used, there is a minimum death benefit guaranteed which would pay a residual death benefit of $28,000.
This example highlights how qualified assets can be repositioned to provide significant long-term care benefits without the risk of losing the premium dollars if care is never needed. As our population ages, the strain on the healthcare system will only become more strained, putting increased pressure on public financing options. A little advanced planning can help ensure that your family members aren’t burdened and the savings you worked so hard for is protected.