Saturday, November 23, 2024
Planning for retirement and living on a fixed income are challenging enough, but an unexpected stay in a nursing home can, to paraphrase Robert Burns, render even the best-laid plans and leave us nothing but grief and pain. Two-thirds of retirees will ultimately need some form of long-term care and the costs are enormous. Ranging from $20 an hour, or more, for a regular housekeeper or visiting health aide to over $225 a day for a stay in a nursing home. Conventional health insurance and Medicare pay very little or nothing. So, what are mice and men to do?
Annuities can be a valuable tool in retirement planning. They provide tax-deferred accumulation and guaranteed lifetime income, but what is less well known is that many annuities can provide substantial, enhanced payments if you need long-term care.
Annuity Long Term Care coverage is a rider to the annuity policy. It is optional and the annuity carrier charges a fee of about 1% of assets per year to pay for this coverage. The rider provides for increased payments, often two to three times what might otherwise have been paid to the owner, for as long-term care is required. If funds in the annuity account are depleted, payments continue for an extended period (generally two to six years) again, as long as long-term care is still needed.
Imagine buying a house for $300,000. As your home and probably your most valuable asset, you’d want to insure it for fire or theft. You could purchase a Homeowner’s Insurance Policy and make annual premium payments forever, an expensive proposition. Or, knowing that most homeowners insurance policy losses are just a fraction of the home’s value, you could put $100,000 into an investment account and set those funds aside, at interest, to pay for any claims.
Now imagine that you invest this fund into an annuity with a “Homeowner’s Insurance Rider” and, in the event, you suffered a loss, your fund would increase to $300,000. Of course, while there is no such thing as an annuity with a Homeowner’s Insurance Rider, this nicely illustrates how an LTC rider can replace a conventional LTC policy.
An LTC policy and the annuity rider cover the same “perils,” those being the Activities of Daily Living. While they would undoubtedly have differing terms, limits and conditions, which any investor ought to consider carefully, the goal is largely the same.
Would the $100,000 investment account grow more slowly than your other investments due to providing this “Homeowner’s Insurance” coverage? Of course it would. But, it would grow and if you never had any fires, thefts or other homeowner’s losses, you could use the investment for other purposes or leave it intact for your heirs.
Both LTC riders and LTC insurance policies make specified payments to cover nursing home, assisted living, or in-home care if an insured person cannot perform some number of the Activities of Daily Living. LTC policies generally make a specified monthly payment, for a fixed number of years after an elimination period of fixed a number of days. An elimination period is like a deductible. An LTC policy with a 30 day elimination period will have a higher premium than one with a 365 day elimination period but will, in the event of a claim, begin pay after one month instead of after twelve.
Policies, of course, require a periodic premium – annually or monthly. LTC insurance policies usually do not have guaranteed premiums after the first year, and those premiums can – and usually do – increase. These increases can result in policyholders lapsing their coverage just when they may need it the most. LTC policies are also underwritten. This means the insurance company reviews an applicants’ medical history and their application might be rejected.
Annuities with LTC riders, on the other hand, are generally purchased with a lump sum and can earn interest like any other annuity. If long-term care is never needed, the investor still gains the other benefits of their annuity investment. LTC riders can vary in the time before payouts begin. With a provision not unlike an elimination period, some riders start paying immediately after a claim is submitted, while others delay benefits for anywhere from three months to a year. The annuity/rider combination will likely have some medical qualification and investors in an annuity with an LTC rider will have to answer some medical questions; the annuity solution’s qualifications are less strict than for an LTC policy.
All annuities are different and this is an area where there has been a great deal of innovation by insurance carriers. Investors should, as always, read and understand the provisions -- and costs -- of any annuity they are considering. But generally, the long-term care "fund" is a multiple, often 300% to 400% of the amount invested, which can be paid out over a period of years, again typically four or five, up to a daily limit. This daily limit is usually set to a similar limit set by the IRS and above which distributions would be no longer consider long-term care payments and would be taxable.
For example, if you invest $100,000 in an annuity with a long-term care rider, your long-term care "fund" would be $300,000. If at some point, you require long-term care, that fund could be paid out up to the IRS daily limit. If and when those distributions exhausted the balance, payments would continue for a period of years or until you no longer needed long-term care.
If an annuity owner uses the LTC distributions for some period of time, then no longer needs the coverage, any unused portion of the original account will continue to earn interest and can be used to pay for long-term care in the future.
For example – 50-year old Janice buys an annuity with an LTC rider for a single deposit of $100,000. After fees, the annuity guarantees a 3% annual return, and the terms of the LTC rider guarantee her a maximum payout of 300% of the account value for long-term care. At age 62, Janice has a mountain biking accident that requires her to go through a month of assisted living in a rehabilitation center, followed by six months of part-time in-home care as she recovers.
At the time of her accident, her annuity is worth $143,286. To cover her long-term care expenses, she activates her LTC rider and begins to receive monthly tax-free payouts of $5,970. At the end of her 7-month rehabilitation, Janice deactivates the rider. Her annuity account is now valued at $101,494, and resumes its accumulation phase, gaining value under the same terms as before she needed to activate the LTC rider.
If Janice ever requires long-term care again later in life, that account, and all of its benefits, will still be available to her. If she requires nursing home care at age 82, her annuity is now worth $184,795. Re-activating her LTC rider will now bring her $7,699 a month to cover nursing home fees or full-time in-home care. These payments will deplete her account in two years, but the LTC rider guarantees her four more years of the same payments as long as she requires long-term care for a six-year payout total of $554,385.
LTC rider fees are charged as a percentage of the annuity account. Typically, policy charges for a rider are around 1% per year for a 65-year-old. Those charges increase or decrease based on the age of the person buying the annuity. Some insurance companies offer pre-bundled hybrid annuity/LTC plans that don’t charge rider fees directly and instead pay below-market interest rates compared to an annuity without an LTC rider. The result is the same – an LTC rider reduces expected returns on an annuity by about 1% per year.
These charges may be hidden but are not insignificant and ought to be carefully considered. For example, charges for an annuity with an initial investment of $100,000 would be about $1000 annually for the LTC rider. That’s less than the premiums for an equivalent LTC policy. However, if the annuity grows to $200,000 over the ensuing 20 years, the rider charge would likewise have grown to $2000 per year. The total rider charges, over the twenty years, would exceed $30,000. The lost interest would be greater than that.
These charges are still likely to be less than the premiums on an equivalent LTC policy and would be considered money well spent in the event of a potentially devastating claim. However, these charges are real and will dramatically impact your investment results. Investors should consider them carefully.
What are the tax consequences of receiving LTC benefits from my annuity?
Withdrawals or distributions from an annuity are generally taxable to the extent they exceed the original investment. This is a complex topic and will be examined in-depth in another post. But, thanks to the Pension Protection Act of 2006, annuity distributions used to pay for long-term care are tax-free.
Generally, LTC riders can only be added to an annuity at the time of the initial investment. Existing annuity balances can, however, be liquidated and transferred into a new annuity through what is known as a Section 1035 Exchange. A 1035 Exchanges does not subject the investor to taxes or tax penalties and have become routine in the industry as annuities providers have continued to innovate. If an investor decides he wants or needs an LTC rider, he can easily transfer from one into the other. However, the original annuity can still be subject to surrender charges, especially if it is a relatively new account.
Annuities are primarily retirement savings vehicles. They provide tax-preferenced accumulation and efficient, guaranteed lifetime distributions that you cannot outlive. Many modern annuities also have an option to provide for Long Term Care benefits, an option that continues to grow in popularity. For many investors, an annuity is an excellent tool to provide for this otherwise challenging and expensive exposure.
