Understanding Your Future Long-Term Care Needs — Part III

This column is the third of three columns discussing the issue of long-term care and what federal employees should know in preparing for their likely future long-term care costs. The first two columns discussed purchasing long-term care insurances, including purchasing an individual long-term care insurance policy offered by about half a dozen insurance companies, or purchasing a group-sponsored long-term care insurance policy such as the one offered by the Federal Long-Term Care Insurance Program (FLTCIP).

Long-term care insurance has its disadvantages, including not every individual can qualify for it, premiums can be unaffordable, and benefits paid by the insurance company may not be deployed as soon as the insured needs them. It is therefore important to discuss some of the alternatives to buying long-term care insurance for the purpose of how individuals can pay for future long-term care costs.

Alternative #1: “Self-insuring” by saving money for future long-term care expenses.

If an individual has robust savings (preferred tax-advantaged savings such as a sizeable Thrift Savings Plan account and/or IRAs), then the individual may be able to pay for future long-term care expenses “out-of-pocket”. The advantage of this strategy is that the individual does not risk paying premiums for insurance that the individual may never use.

The disadvantage of this strategy is that it can result in a big dent in an individual’s retirement savings as well as potentially leaving less money for beneficiaries. It could also be possible an individual could also completely deplete his or her TSP and IRA savings given the high cost of long-term care in certain areas of the country, especially if the care extends for more than a few years.

Alternative #2: Tapping into “living benefits” on a life insurance policy

This feature is sometimes called “accelerated death benefits” and is available in most permanent life insurance policies such as whole life insurance. Some term life insurance policies also offer this feature as a rider to the policy. The “living benefits” rider allows the life insurance policyowner to take apportion of the life insurance death benefit payout while he or she is still living in order to pay for medical expenses, including long-term care. The death benefit will then be reduced by the amount used to pay long-term care expenses.

The advantage is that the cost for this benefit is included in the premiums paid on some life insurance policies, or if it is not included, it can be added for a small cost when the policy is bought.

The disadvantage of having this rider as part of a life insurance policy is that the “triggers” for when the life insurance policyowner can access the policy death benefit in order to pay long-term care expenses can vary by insurance company. It is therefore important to read the “fine print” in the insurance policy.

A “trigger” could be a diagnosis of a terminal illness. Using the life insurance policy to pay for long-term care expenses also reduces the potential payout of the life insurance proceeds (that is, the death benefit that the policyowner’s beneficiaries will get).

Alternative #3: Selling one’s life insurance policy

Anyone who owns a cash value (permanent) life insurance policy may be able to sell the policy and use the net sales proceeds for anything he or she wants including paying for long-term care expenses.

The advantage of selling the policy is that the net proceeds received from the selling of a cash value life insurance policy – a transaction called a life settlement or a viatical settlement – are usually more than what would be received compared to if the policy would be simply surrendered for its cash value.

A disadvantage is that the net sales proceeds will likely be taxed. Another disadvantage is that the life insurance beneficiaries will no longer receive a death benefit from the policy. This is because the new owner of the life insurance policy will receive the death benefit.

Finally, it can be difficult to determine if the policyowner is actually getting a fair price for the life insurance policy. Life or viatical settlements generally are not available for term life insurance policies.

Alternative #4: Use an immediate annuity

An individual can buy an immediate annuity to provide a steady stream of income to pay for long-term care. With an immediate annuity, the purchaser (the “annuitant”) pays a one-time lump-sum amount of money to the annuity provider, usually an insurance company.

The annuity provider then provides a guaranteed stream of income for a certain period of time or for the rest of the annuitant’s life. The amount of income paid to the annuitant depends on the amount of the annuitant’s lump-sum payment, the annuitant’s age at the time of the annuity purchase, and the annuitant’s gender.

The advantage of an immediate annuity is that it can be purchased even if the annuitant is in poor health. In fact, an annuitant who is in poor health usually receives a higher payout from the annuity compared to an annuitant who is in good health because of an expected shorter life expectancy.

The disadvantage is that a large lump-sum of money is needed to purchase the annuity, typically at least $50,000. The income from the annuity may still not be enough to pay for the annuitant’s future long-term care expenses.

Finally, the tax implications of annuities are complex. Potential purchasers of immediate annuities are therefore encouraged to talk to a tax professional before they purchase am immediate annuity in order to understand the tax consequences of annuity income.

Alternative #5: Buy a combination long-term care/life insurance policy

Long-term care/life insurance policies, also called asset-based or hybrid life insurance policies, provide an amount of money for long-term care if it is needed.

In case long-term care is not needed, or if the policyowner does not use all of the policy cash value to pay for long-term care, then upon the death of the policyowner at least a partial death benefit will be paid to a beneficiary. This type of an insurance policy typically requires a large premium upfront in the order of $75,000 to $100,000, or a few large payments over a few years.

The advantage of these policies is the policyowner or the policyowner’s beneficiaries receive some type of benefit from the policyowner’s investment in the policy even if the long-term care portion of the policy is never used. That is, a beneficiary gets a payout upon the death of the policyowner.

The disadvantage of the policy is that a large sum of money has to be paid just to obtain the policy.

Alternative #6: Buy a shorter-term long-term care insurance policy and self-insure for possible longer periods of long-term care.

Shorter-term long-term care insurance reimburses the policyowner for the same types of care as longer-term long-term care policies but for a shorter period of time. This period of time is typically 3 months to a year. Shorter-term long-term care policies also have no elimination period or waiting period. This means that the policy starts paying as soon as the insured incurs a need for long-term care.

The advantage of a shorter-term long-term care insurance policy is that the premiums are cheaper, and the insurance is also easier to qualify for compared to a longer-term long-term care insurance plan. Although the policy will pay for long-term care for less than a year, it may turn out that the insured may in fact need long-term care for less than a year.

The disadvantage of a shorter-term long-term care policy is that there is no coverage if the insured needs care for more than a year. In that case, personal savings will be needed to pay for long-term care expenses. Many states also do not regulate shorter-term long-term care polices as tightly as they regulate longer-term long-term care polices. More caution needs to be exercised in buying shorter-term long-term care policies.

Planning for how to pay potential long-term care expenses in the future is obviously a challenge. Anyone looking to buy a long-term care insurance policy is advised to speak with a trusted financial advisor to discuss other possible ways to pay for future long-term care expenses. A fee-only financial advisor who does not earn commissions on product sales and who can provide unbiased recommendations would be an ideal financial professional to work with.