June 27, 2014 | By Ben Mattlin
We know baby boomers are turning 65 at the alarming rate of 8,000 a day, according to AARP. And with this aging population comes a greater need for ever-costlier long-term care (LTC) services. LTC insurance is gaining traction, despite rising premiums.
What’s less well known: More and more people are using life insurance to help with LTC expenses. But exactly how and under what circumstances? The answers are complicated.
Hybrid Or Combo Policies
To be sure, there are those who are loyal to stand-alone LTC policies. “It’s the simplest and most direct way to cover LTC risk,” insists Portsmouth, N.H.-based Paul Forte, CEO of LTC Partners, a division of John Hancock. Yet others recommend life insurance with LTC benefits. “Many of my clients are faced with a budgetary dilemma—do I put my money into life insurance or LTC insurance?” says Gary Bottoms, president of the Bottoms Group in Atlanta. “A lot of them like the combo plans because they know they’re going to get their money back one way or the other—either through a death benefit or for long-term care. It kind of hedges things.” LTC riders are available for universal life, indexed universal life, variable universal life and whole life policies. Riders and hybrid plans generally have less stringent underwriting requirements than stand-alone LTC policies. “You don’t have to take a physical to qualify,” says Kevan Melchiorre, a private wealth advisor at Busey Wealth Management in Champaign, Ill. Moreover, they can “help protect savings from catastrophic LTC costs,” observes Mike Hamilton, a vice president at Lincoln Financial Group in Greensboro, N.C. “These types of policies offer income-tax-free reimbursements for qualified long-term-care expenses and income-tax-free death benefit if LTC is not needed and also typically include some form of return of premium option, eliminating the ‘use it or lose it risk’ associated with stand-alone LTC policies. [And] the cost of coverage can never increase, which has been a common issue for stand-alone LTC policies.”
But there are disadvantages. Many hybrid plans’ premiums are not tax-deductible as a medical expense, which stand-alone LTC insurance premiums are. (In either case, qualified distributions for LTC expenses are tax-free, though other payouts from life policies usually are not.) They also often require deeper pockets up front. “The LTC riders themselves tend to be expensive,” cautions Melchiorre—adding perhaps as much as 0.25% of the policy’s face value to the cost. Also, LTC payouts eat into the policy’s cash value or death benefits. What’s more, as with most life insurance plans, clients who are trying to qualify for Medicaid will have to spend down the policy’s cash value before receiving government benefits, which is not true with stand-alone LTC policies that have no cash value.
Perhaps worst of all, they “may not have all the flexibility [of a stand-alone LTC policy],” says Jeffrey M. Verdon, an estate planning and asset protection attorney in Newport Beach, Calif. They might not cover the full range of LTC services—nursing homes, assisted living, in-home help, etc.—or offer inflation protection. On the other hand, he adds, “Stand-alone products do not build up cash value.”
Chronic Care Versus LTC
In addition to LTC, some life policies offer a chronic-care rider. The difference is partly technical—they fall under different sections of the tax code—and partly practical. “For all practical purposes, the major difference is that chronic illness requires a permanent condition for a claim payment,” says Edward Kohlhepp Sr. of Kohlhepp Investment Advisors in Doylestown, Pa. “A broken hip, for example, may not be a permanent condition and could generate payments from a long-term-care benefit but not from a chronic-illness rider.” Earlier this year, New York Life announced a chronic-care rider as a premium option for newly issued standard and custom whole life insurance policies. It requires an additional charge of roughly 4% to 6% of the premium, says Craig DeSanto, a senior vice president at New York Life, for “a benefit amount set at the time of purchase, giving you certainty in your coverage and known effects on your policy (dollar for dollar reduction in death benefit, and proportional reduction in cash value.)” Term life insurance may offer a chronic-care rider, too, though almost none offers LTC. The reason is simple. “Most term policies end before you are likely to need LTC benefits,” says David Shucavage, president of Carolina Estate Planners in Wilmington, N.C. “Companies don’t like to sell you term when you are likely to die of old age. And if they do the premiums are so high; if you don’t die the premiums are lost.”
For those who cannot qualify for insurance, an annuity with an attached LTC or “confinement care” rider might make the most sense. The latter is similar to the chronic-care option. A fixed indexed annuity with an income rider that can also be used for confinement care will double the contractual income guarantee when the confinement care is triggered. That happens whenever the insured person can no longer do two of six activities done in daily living—bathing, dressing, toileting, continence, feeding and transferring out of or into bed.
“Only by spending some quality time with one’s professional advisor can a decision be made,” says W. Allen Johnson, executive vice president at iTrust Advisors in Syracuse, N.Y. “If an annuity is recommended as part of the financial plan, then the withdrawal features for a chronic illness should be explored.” In general, these annuities function much like their life-insurance counterparts. They don’t require a physical exam but do require a large up-front investment. On the other hand, premiums never increase. “Generally, the LTC component is two or three times the face value of the annuity,” says Melchiorre. “If you don’t use that component, you can redeem the accumulated value of the annuity down the road or annuitize it to get income for other purposes.” This option has swelled in popularity since a 2010 ruling that classified withdrawals for qualifying LTC expenses as tax free—unlike confinement-care benefits, which are taxable. Either way, the distributions reduce the annuity’s accumulated value. Deciding among all these options depends on where your clients are coming from. “Let’s say they have held an annuity they bought at 55 for 10 years, which now has a death benefit of $100,000,” says Steve Williams, vice president of Financial Planning Strategy at BMO Private Bank in Chicago. “And now that they are age 65, they start to worry about [an] LTC event. By doing a 1035 [tax-free] exchange to an annuity with LTC rider, they can typically get anywhere from $300,000 to $400,000 LTC coverage. If it is new money, then the permanent policy [universal or whole] with [an] LTC rider is typically a better option.”
Leveraging Life Insurance Cash Value
Even if you reject these hybrid options, life insurance can still be used to help fund LTC expenses. First, accelerated death benefits—usually available at an additional cost—allow you to take “a tax-free advance on your death benefit while you’re still alive,” says Melchiorre, “but you must be terminally ill or severely cognitively impaired.” In most cases, eligibility must be recertified annually. (“Terminally ill” is typically defined as having less than two years to live.) Generally capped at 50% of the total death benefit, the distributions usually go for an immediate need, though at times they can be used for monthly LTC services. There are “limitations on what is considered covered or qualified care,” says Celeste Moya, vice president of product analysis at NFP International Insurance Solutions in Austin, Texas. “Qualified care generally includes care within a facility—nursing home, hospice care, etc.—and expenses related to room and board at any one of these facilities. However, there is no standard across the industry.” Another option for the chronically or terminally ill is a viatical settlement or, for those with a less urgent need, a life settlement. Both are ways of selling a life policy to a third party. They are solutions of last resort. Many desperate senior citizens have been swindled. “The amount of the sale must be greater than the cash surrender value of the insurance policy, but less than the death benefit,” Melchiorre says. With viatical settlements, you may receive between 60% and 90% of the policy’s face value. If you are terminally ill, the proceeds are not subject to tax. If you’re chronically ill but not deemed terminal, the proceeds are only tax-free if used to pay for LTC needs that aren’t covered by other insurance.
LTC Benefit Accounts
Life policies with a cash value can also be converted to an LTC benefit account—a “privately funded irrevocable account funded by the sale of a life insurance policy,” says Chris Orestis, CEO of Life Care Funding, a senior care advocacy group in Portland, Maine. The account is held by a professional administrator, who makes monthly tax-free payments on your behalf directly to LTC providers you designate. All levels of care and health conditions are eligible. Even funeral expenses are included. There are no premiums, and most types of insurance qualify for conversion, including group and term plans. It’s an allowed method for spending down assets to qualify for Medicaid, too, unlike other uses of a life policy’s cash value. But your need for care must be imminent, if not immediate.