YOUR LIFE’S FINAL costly chapter may be paying for long-term care. Indeed, the odds of needing care if you’re age 65 or older are around 50%.
Two key questions: Will you need care for an extended period and how will you pay for it? If the duration is short—which it is for many seniors—paying probably won’t be much of a problem. But if long-term care is needed for many years, financial decisions today might protect the legacy you hope to bequeath decades from now.
Long-term-care (LTC) insurance can take the form of either traditional standalone coverage or a hybrid policy. It’s possible that current standalone policies, after being underpriced for many years, are now priced correctly. Still, I never wanted to make a long-term investment in a policy where premiums could jump if the insurer’s “costs” rose.
That’s why I opted for a hybrid policy that “guarantees” no increase in premiums. The company I chose for my hybrid policy hasn’t raised premiums on its hybrid LTC policies in more than 30 years, which I find encouraging.
A hybrid LTC policy is one that’s built around either a life insurance policy or a tax-deferred annuity. The basic idea: If you don’t need long-term care, your heirs will receive either a tax-free death benefit or the tax-deferred annuity. If you do need care, you’ll receive the benefits tax-free and, in some cases, the monthly benefit can be of unlimited duration. Intrigued? This is a good time to be looking. For the first time in a few years, the cost of hybrid policies has declined, thanks to rising interest rates.
When I bought my policy some years ago, I paid a large lump sum for a second-to-die life insurance policy. Yields on cash investments were incredibly low at the time, so depositing a hefty premium with the insurance company struck me as a good use for my conservative money. But as I’ve further researched hybrid policies, I’ve learned of two other funding methods that are appealing, though they’re also a little more complicated.
One method is to exchange an existing tax-deferred annuity for a hybrid LTC insurance annuity. This is an attractive way to defer the annuity’s taxable gain—and perhaps avoid the tax bill entirely. If the hybrid annuity is later used for LTC, the benefits received are tax-free. The Pension Protection Act of 2006 created this “loophole” to encourage the sale of LTC insurance.
I convinced a friend to use this strategy. He had invested $150,000 in a tax-deferred annuity that was now worth $300,000. He exchanged the annuity for an LTC annuity. If he eventually receives LTC benefits from the annuity, he’ll receive the benefits tax-free, thus sidestepping taxes on $150,000 in gains. The annuity covers both himself and his wife. Even though my friend is wealthy and can afford to pay LTC costs out of pocket, the better solution was to receive LTC benefits tax-free, especially given his high tax bracket.
Another funding option might be the most useful: buying the policy with your IRA. Tax-deferred IRA and 401(k) money is often a retiree’s largest investment. After age 59½, when the 10% early withdrawal penalty no longer applies, you might withdraw, say, $6,000 a year from your IRA to buy a hybrid LTC life insurance policy.
After 10 years of $6,000 annual payments, the policy would be fully paid up. If the policy isn’t used for long-term care, it can provide a death benefit for your heirs. To be sure, taxes will be due when the $6,000 is withdrawn each year from the IRA. But that’ll likely be more attractive than paying taxes on $60,000 withdrawn in a single year.
James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. Check out his earlier articles.
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When I was looking into a LTC policy, the insurance agent from a popular agency came to my house on a Sunday. I asked him outright what his commission was and he told me 40%. I took a pass.
My “guess” is that he meant 40% of the commission. On life insurance the first year payment is primarily commission. 40% seems rather rich indeed.
Thanks for the article. I always thought I would self fund LTC, especially since most people are only there for a limited time.
I understand that some LTC companies have exited the business. What happens to their customers when that happens? Do they lose the premiums they have already paid?
When they exit that usually means they have stopped writing new business and policies go into run-off mode. No more business is written but the old polcies stay in place.
Real Life Example:
had a client that passed away a few years ago, and luckily had enough assets to pass on to their children. In this instance, everything worked out by self insuring him. He would have done it another way if he could have, being that he was uninsurable.
the average life cycle of a person with an LTC event is less than 6 months to 2 years. Unfortunately, he spent 3 years in care that cost him 7500/month. Do the math, he literally spent 309k towards this LTC facility. Of course if you take the offset from social security and he had a pension, some of it was covered by guaranteed income, so that is a consideration.
if we could insure him, we would have offset his LTC by maybe 2k a month to make sure we put enough away to cover those cost. It may have cost us say 100k to purchase the policy, saving him 200k of outlay.
The kids received a large amount each and there were no real issues, but, the moral of this story is that there was a more efficient way to use capital.
Great article James. You are very knowledgeable as always. LTC, much like investing, is a decision you must make with the future in mind. Like James mentioned, it’s 50% probability and most likely adding a burden on your children when this occurs. For those who say don’t bother, that’s fine just have a large amount of assets stowed away to cover any and all contingencies, but that is less likely than having an insurance company cover that cost for a fraction of the amount you would need to stow away. To each his own, just don’t be a burden on your children or the state.
Very interesting article and discussion
Given that the median net worth of seniors in the US is probably less than $200K, it is not surprising that LTC insurance policies have been priced so poorly. Insurance companies need a lot of LTC insurance holders who eventually do not need their LTC insurance to pay the claims of those who do need their LTC policies. That is how insurance works.
Can you give insight into the criteria for deciding whether or not someone should get a LTC policy in the first place? What are the net worth constraints or other factors that you would use?
Have you ever heard of state Partnership LTC policies which are sponsored by states that have a 2 fold purpose: encourage people to buy LTC insurance to minimize the impact of LTC spending on state Medicaid budgets by allowing them to protect more of their assets from Medicaid seizure? I purchased a policy 15 yrs ago that has policy value currently of $500K(daily coverage value increases by 5% each yr) and the premium increases(which are intermittent) have a smoothed average of about 2% a year over that time.
Yes I have heard of the Partnership LTC policies that permit people to keep some assets if they have LTC insurance equivalent. Have you heard about the state of Washington and its attempt to impose a payroll tax to pay for LTC insurance?
This is the first statewide attempt to motivate workers to purchase LTC insurance and is the buzz in LTC circles.
Regarding criteria and net worth considerations that is difficult as everyone has different circumstances. I would say to inquire into LTC insurance at age 50 is or late 50’s. If buying a stand-alone policy would be too much of a drag on lifestyle then at least you have addressed it. I have confidence in hybrid policies and would say that if you can afford them then guesstimate 4% of net worth. Of course if really interested research the products and find someone who can show you examples. I just know that having my hybrid policy in place gives me peace of mind and should cover my last major expense.
Whether or not it is a good idea what Washington state is doing, residents of Washington state are already paying for medicaid through their income taxes now.
And they will be paying more with the premium increase. On LTC conference calls they stated that the tax can be offset if the workers have adequate LTC coverage. There was a mad rush in Washington to avoid the tax by applying for policies. Will see if this is a harbinger or an aberration.
Leaving a legacy is a matter of complete indifference to me, and I haven’t carried life insurance for decades. Happily, I chose not to take out LTCi when my employer offered it, and therefore have not been subject to increased premiums. I am dealing with the prospect of needing care in the future by moving to a CCRC with Assisted Living and Skilled Nursing on site, with a promise not to throw me out if I run out of money. My back-up plan for dealing with a diagnosis such as Alzheimers is a one-way ticket to Dignitas in Switzerland.
I would be interested to know what fees are charged for this complex product.
I understand the Dignitas back-up plan. I wanted an option that had home health care fully funded versus the one-way ticket good-bye. After 2 years life insurance policies will pay even for suicide. The fees for the product are probably 3-8% of the premiums-different policies have different commissions.
I prefer a quick exit to a long befuddlement, but we should all be free to make that choice for ourselves. Given my investments are mostly in Vanguard mutual funds, and have been for years, I find those fees steep.
You are not free to make that choice because once you are diagnosed, you lose all freedoms. Make sure you have a Will and MPOA or medical directive setup stating your wishes. If you prefer a quick exit, make sure everyone understands your wishes as to not lose control of your life.
I have a will, a living will, an advance directive and a Health Care POA with a friend who is very, very good at saying no. All updated three years ago, plus DNRs in my house, my car and my handbag. I have discussed my wishes with the relevant people, who are on the same page. An initial diagnosis of dementia is unlikely to prevent me buying a plane ticket.
Unfortunately paying for long term care is not an index fund. One difference is that AUM fees are forever and commissions are one time.
If AUM is “assets under management” I don’t pay those fees. Every few years I pay a flat fee to a fee-for-service advisor to run the numbers, but I don’t pay an advisor annually. Now, my CCRC fees will be monthly, but they cover more than future medical care.
What is CCRC if you don’t mind me asking?
Howard Rohleder wrote a good article on the topic:
Continuing Care Retirement Community aka Life Planning Community. A full CCRC provides Independent Living, Assisted Living and Skilled Nursing (and sometimes Memory Care) on the same campus, sometimes in the same building. You transition between levels of care as needed. See: https://en.wikipedia.org/wiki/Continuing_care_retirement_communities_in_the_United_States If really interested look for an e-book by Ruth Alvarez. In my state they are licensed by the Dept. of Insurance: https://www.ncdoi.gov/insurance-industry/continuing-care-retirement-communities-ccrc
The real purpose of LTC is to have the right to decide whether to have in-home care or if a facility may be needed. My clients purchase LTC for the right to stay in the home and have skilled nursing versus needing to go to a facility. Most of us would choose dignity to live out our final days around our loved ones and in a comfortable setting versus the alternative, and that is what LTC provides us, with a decision.
A carefully chosen CCRC is an excellent alternative to LTCi. The scenario you posit may work out for one member of a couple, but is unlikely to work as well for a surviving spouse, never mind a single person.
At Vanguard the AUM fees are very small not zero. There are fees for ETF’s as well. They are much smaller than active fund fees but Vanguard still has to make money too.
Vanguard charges a 0.30% AUM fee if and only if you choose to use their Personal Advisor service. I have never done so, nor do I own ETFs. I do pay an expense fee on my mutual funds, which Vanguard tells me is currently 0.10%/year. (It would be lower but I still have some money in the Tweedy, Browne International Value Fund.)
Expense fee = management fee. Yes very small.
Who would disagree with that statement?
Thanks for the article. I can definitely see how converting a cash value life insurance policy to a hybrid LTC policy could make sense to avoid taxes on the distributions from the insurance policy. But for the IRA, since you are paying the taxes on distributions, I don’t see much benefit there. The comparison of withdrawing smaller amounts incrementally vs larger amounts at once from a tax-deferred account is just tax planning and should be considered by any retiree regardless of long-term care funding.
I don’t know. I’m hesitant to buy “hybrid” products. Many people late in life naturally decrease or eliminate their life insurance as their assets grow and their children become self-sufficient adults. It certainly depends on the situation, but for people with no desire for life insurance, I don’t see that it makes much sense for these folks to take on a hybrid LTC policy.
From what I’ve read, if you’re paying identical premiums for standard LTC coverage vs. hybrid LTC coverage, there are pretty dramatic differences in the long term care benefits you receive should you need them. You would have to pay substantially more in monthly premiums on a hybrid LTC policy to achieve a comparable amount of LTC benefits should you need them. I understand there is the chance you will “lose” money to a standard LTC policy should you never need it, but to me that’s just the nature of insurance.
You also acknowledge, and I agree with you, that the increases and jumps in LTC premiums were likely due to widespread mispricing in the industry when these policies were newer. I tend to believe that this “glitch” has been fixed and that premium increases will be more modest in the future.
Again, I wouldn’t discount hybrid LTC policies for everyone, but I would consider it carefully to determine if it suits your needs before jumping in.
Brent thanks for your comments. The annuity conversion (not life insurance cash value) of taxable gains to taxfree LTC distributions is quite attractive.
The IRA example is actually more complicated than I wrote as I didn’t want to go into the “weeds” in the article. However in the “weeds” you would take $50000 from the IRA and buy an LTC fixed annuity that kicks off $6000 a year for 10 years. (The insurance company gives a 20% bonus for the annuity to make it more attractive.) By giving over $50000 to the insurance company the LTC coverage purchased is greater than the annual $6000 premiums for 10 years.
The aversion to “buying more life insurance” later in life as the children are self-sufficient if we are talking about just a death benefit. The death benefit in hybrid LTC policies is only of secondary importance. My personal example from 8 years ago might make it more understandable. I paid $78000 lump sum for a second-to-die death benefit of $208000. This death benefit provides me or my partner up to $100000/year for LTC expenses. I also pay an annual premium of $2500 so that the $100000 never runs out. The death benefit was incidental to my purchase. My goal was to get an insurance company to cover my LTC expenses of $100000/year.
Stand-alone policies provide a bigger bang for the buck and “hopefully” the rates are such that they don’t need to be increased dramatically over time. There are no price guarantees for them. I do have a friend who has an inexpensive stand-alone policy but also added a hybrid policy funded from his IRA as a hedge in case the stand-alone premiums rise too much over time.
>>However in the “weeds” you would take $50000 from the IRA and buy an LTC fixed annuity that kicks off $6000 a year for 10 years.
I thought the QLAC max is the lower of $145k or 25% of the IRA value, for moving from an IRA.
Or did I misunderstand you?
This is not a QLAC. This would be buying a fixed LTC annuity from the insurance company that would fund the policy over 10 years. The QLAC is a deferred annuity that pays out in the future.
James, thank you for this, a very timely article for me. I had done similar research in 2019 and punted after considering the dizzying array of choices. I had previously done a 1035 from a Comp life (half whole life/half term) to a variable annuity to avoid taking a tax hit.Your article resonates.
I have yet again undertaken some level of research on this topic and my conclusions are, the standalone (a.k.a traditional) LTCI is not worth given its limitations. As in, the premiums tend to go up (virtually all insurance companies have raised them in the recent past is my understanding), and no insurance company is going to pass up this opportunity (IMV). Even if the premiums are level for rest of one’s life (which I am very doubtful), I find that in about 20-25 years of time, this premium will be close to a single premium hybrid. And (like auto insurance), is the insurance company likely to raise the premium once you use it? I would not be surprised. And if they do raise the premium, you’re kind of boxed in because you’re unlikely to get new LTCI. While the value of the variable annuity that I have, in of itself is likely good enough to “self-insure”, I will likely go the route of buying LTCI. My view (personal view, your mileage may vary) is that, I don’t need to insure for the potential worst case (and pay the top premium dollars in the process). My goal is to insure for about 50%-60% of the anticipated monthly costs for an event that may or may not occur. And if does, we just can’t tell when or the severity. This to me is an equation where we can’t solve for all the variables in it, so level of insurance is prudent.
One thing I learnt (the hard way), once you’re in an annuity, you can only do a tax free 1035 to another annuity product. You can’t go from an annuity to a life insurance product. Annuity based LTCI products in general seem to be slightly sub-par compared to the whole life based riders (my view again). I have been made aware of just 2 companies that allow for a 1035 for annuity based LTCI. And I discounted one of them, since it was essentially giving me what I paid into it, zero IRR in other words. I will likely go ahead with this in the coming weeks. My conclusion (and this is generally true for annuities), avoid any complex annuity based products. Just stick to the fixed income annuity.
@Brent – I agree with you that most of us don’t need to life insurance product at this stage in our life. But I look at this a bit differently. Traditional LTCI (or standalone as I call it), besides the likelihood of facing increasing premium, is also a use it or lose it policy. God willing if we live for the next 20-30 years and not avail of this policy, then that the premium money paid (while providing peace of mind during the time when it was in force) is for naught. All the LI or Annuity rider is doing is to ensure that you get value in either or case. And the premium is one and done (although there are 5pay or 10pay’s, they tend to be a bit more (not a small amount) than paying in one shot). And I know this is a chunk of change but like James said, if you have tax deferred money piling up (either in an annuity or LI), then this is appealing.
>>if you’re paying identical premiums for standard LTC coverage vs. hybrid LTC coverage, there are pretty dramatic differences in the long term care benefits you receive should you need them.
And this, I have not seen and would be curious on your finding. If this came from a LTCI salesperson, then I would slightly discount it.
Thanks for your comments. I agree about the dizzying array of choices. (I wrote a small book about some examples of hybrid policies at different ages.) You mention not planning for the worst case scenario which I agree with. Another interesting rule of thumb ratio I ran across is 4% of net worth for the premium. Most people want to avoid thinking about LTC but I preferred to address it. If you don’t set aside a specific amount for insurance it is possible you will either delay paying for assistance or spend substantially more in expenses than if you had insurance.
James, Thanks again. And you’re right, it is quite depressing topic to tackle and I think it would be far more depressing to find that we need this (or a similar) policy sometime down the road. Like I said, a few variables that we can’t solve for.
James, thanks for an interesting article about I topic I know little of. You’ve inspired me to do some research.
You are welcome. Let me know what you find out.
Thanks, James. Your articles cover topics that are on my mind during this season of my life.
You are welcome. Long term care is a topic most don’t want to discuss but I’d rather do it sooner than later.