Prudent long-term care planning consists of strategies that minimize the number of assets exposed to loss in the case of an adverse long-term care event.
There are three options available to help protect your estate from an adverse long-term care event:
- Self-Fund: Most nursing home facilities post their monthly costs online. One could use the nursing home’s projections of future medical costs to determine the number of assets needed to provide for their own care. This is a commonly used option, but the associated costs make it unrealistic for many.
- Government-Based Long-Term Care: You can read my blog about this. Hopefully, you are familiar with the concept by now.
- A Hybrid Long-Term Care Solution: A hybrid solution is the best strategy for the current generation of long-term care insurance that is offered by the insurance industry. These policies allow life insurance to be paid early for a long-term care event.
In practical terms, most hybrid long-term care policies are a form of permanent life insurance (whole, universal, index, or variable) that will advance a percentage of the death benefit to the insured, tax-free, if they meet certain qualifications. This means that, under certain conditions, the insured can access the vast majority of their death benefit while they are alive. This is an improvement on previous long-term care policies that provided the consistency of daily or monthly benefits but lacked the flexibility of accessing the death benefit early. Even if the policyholder has a healthy and long retirement without significant medical complications and doesn't need long-term care, they can pass on the death benefit to their loved ones. This frees the policyholder from having to keep a large sum of assets reserved for the future “what if” scenario.
The primary challenge of self-funding long-term care is resource availability. Many Americans hold hundreds of thousands of dollars in IRAs and investment accounts but live in utter poverty. If they would give up the idea that they need to self-fund their long-term care and use a hybrid policy, they could get a policy whose total lifetime premiums are a small fraction of the potential benefits. If they never have a long-term care situation, their loved ones (or a charity) can benefit from the value of the policy. Also, if the policy has a cash value, and the policyholder decides they aren’t concerned about funding a long-term care event, they could always cash out the policy and enjoy those proceeds in their retirement.
Many hybrid policies will allow for up to 80% of the death benefit to be forwarded to the insured if they cannot complete at least two of the six activities of daily living or have a mental impairment. These benefits are often paid out annually, as a lump sum, to the insured to be used however they wish. For example, a seventy-year-old man with Alzheimer’s who has a one-million-dollar life/long-term care hybrid policy could receive, tax-free, 20% of the policy face amount ($200,000) per year, up to a total of $800,000 over 4 years. The amount of the policy death benefit that is not used while the man is alive would pass to heirs, also tax-free.
In each situation, the insured gets value for the premiums they’ve paid.
You can see how this is a more attractive solution for most people, as they are guaranteed one of the following:
- They can cash out their policy and keep the value of the policy;
- They can use the death benefit for a long-term care event; or
- They can have the death benefit payout to their loved ones or a charity.
Life insurance companies are required by law to pay out more than they receive if an insured pays all their premium payments. Why would the insurance company offer a product like this? Quite simply, this generation of long-term care policies puts the insurance companies back in control in two ways:
- They get back to a pricing model they understand…life insurance. History shows they are much better at properly pricing life insurance policies than traditional long-term care policies.
- They limit their risk exposure to a predetermined maximum payout. They know, at the issue of the policy, what their max loss can be…the death benefit. Many early long-term care policies had unlimited years of benefits on the policy, along with inflation riders of five percent or more. By making the long-term care benefit and the death benefit one and the same, the insurance industry took much of the guesswork out of how to price long-term care insurance.
There are many strategies that an estate planning attorney, often working in concert with a skilled financial planner, can put in place to help ensure that wealth is preserved and not exposed to the fallout of a significant long-term care event. Even for those who have the resources to absorb any potential future costs, these planning strategies may still have value.
For my clients who, upon the first reflection, suggest they will just “write a check” if need be, I ask them a simple question: Do you carry full coverage car insurance? The answer is always, without fail, of course. Why? Some, of course, cite the legal requirement, but most understand that if they happen to be in a car accident, they want someone else to handle the situation…the insurance company.
A common strategy for people who have assets outside of an IRA is to create an irrevocable trust that owns hybrid long-term care policies. A gift can be made into the trust, purchasing an annuity, which then funds the life/long-term care policy in perpetuity. If there is a need for the long-term care portion of the coverage, the benefit can be paid out to the insured. If the insured does not need to use the long-term care portion, the death benefit of the policy will pass onto the beneficiaries.
Unfortunately, in the financial planning industry, there are many concerns about purchasing a life insurance policy. The three biggest concerns are:
- The cost of the insurance,
- The client’s ability to keep paying the premium, and
- Whether or not the policy covers a specific long-term care event.
The Cost of Insurance
Insurance agents are paid a commission to sell insurance products. While this is not wrong, it does create a conflict of interest. An insurance agent is paid a commission based upon the cost of insurance, not the performance of the policy. The more the client pays, the more the insurance agent gets paid. To alleviate this issue, many financial planning firms have switched to fee-only financial planning practices. This means the advisor only gets paid a percentage of assets under management.
While this appears to be a good idea, it has had an adverse effect. Many advisors underinsure their clients because they do not want to reduce assets that could be under management, such as investments. The best way to resolve this issue is to develop an intuitive understanding of the cost of insurance. It is primarily based on three things:
- Your expected life span,
- The amount of insurance, and
- The specific benefits that you receive.
The longer your life, the less the cost of insurance. The greater the death benefit, the greater the cost. If you’re a smoker, then you are going to pay more. Taking the time to really understand the cost will help you determine if the product is for you.
The Client’s Ability to Keep Paying the Premium
I have many clients who have paid on a policy for years, only to reach retirement and be unable to pay the premium. This is the result of poor planning. Usually, in my planning sessions, the goal is to have the policy fully funded within seven years, so my clients do not need to make any payments later in life. This is not always possible, but when it is, it is the safest course of action.
Does Your Policy Cover a Specific Long-Term Care Event?
The most frustrating thing for any insurance product is to find out that you are not insured for an event. For example, many people purchase car insurance, only to find out that they did not get the right kind of coverage or they did not get enough insurance. With a hybrid policy, you should understand what you are really covered for in a long-term care event. Take the time to talk to your insurance agent about what you are really covered for, and make sure that it is written in the policy.
Hopefully, as you have read this book and experienced your mother’s long-term care needs, you have learned the value of preparing for your own future. It takes time and money, but purchasing good insurance can drastically affect where you will live and what type of care you will receive.