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Long-term care planning is really hard to talk about. It can be frightening to imagine ourselves with diminished capacity and needing help from others. And since we find it challenging to discuss it, we often don’t plan for it.
Very wealthy people can pay cash for upscale nursing facilities where they’ll receive great care. Those with fewer assets tend to get help from family and friends or Medicaid. Everyone in the middle has two options: self-insure or shift some of the risk to an insurance company.
When a married couple in their 60s receives a long-term care insurance quote of $5,000 to $8,000 per year, they often decide against the policy and think they can use the extra $8,000 to travel. This sounds fun, but it’s not a smart approach. It’s important to have a plan for covering long-term care costs.
Those who decide against buying insurance are, by definition, self-insuring. If you go this route, you must dedicate a portion of your assets to the possibility of needing care. You can never spend that money on a vacation or other big-ticket items, because you never know when you might need it.
Let’s say a married couple retires with $1 million in an IRA and their financial planner tells them they can pull only $40,000 (4%) from the account each year, plus increases for inflation. If they decide not to buy insurance, they should dedicate $150,000 to $300,000 for the possibility of future care, depending on assumptions in regard to return on investment, estimated inflation, the number of years for which they want funding, etc. If the same couple dedicates $250,000 to long-term care, they must reduce their withdrawals from $40,000 per year to only $30,000 (4% of $750,000).
The other possible route involves shifting some of the financial burden to an insurance company. In my financial planning practice, I recommend three different ways for my clients to cover their potential long-term care costs:
Traditional long-term care insurance
If you have a traditional long-term care insurance policy, you’ll pay an annual premium based on your age, health and partner status. Most policies’ benefits kick in if you receive an Alzheimer’s or dementia diagnosis or are unable to perform at least two of the basic “activities of daily living.” These activities include transferring — for example, being able to move from the bed to the couch — bathing, dressing, eating and using the toilet.
If you qualify, your policy will have a waiting period before you can receive benefits. Afterward, it pays either you or your caregiver a daily or monthly benefit specified in the contract until you’ve used up the benefit pool, the amount of coverage you’ve paid for.
Traditional long-term care insurance tends to be the cheapest way to get a lot of coverage.
Hybrid long-term care insurance
Insurance companies realize that people are reluctant to shell out tens of thousands of dollars and potentially receive no benefit, so they’ve created policies that combine permanent life insurance — which has a cash value component — with long-term care insurance. When you need money for long-term care, you withdraw it from your cash value. Once that money is depleted, the insurance company starts to pay for your care. You’ll receive a lower long-term care benefit for the premium, but your heirs will receive your death benefit if you die without needing care — so you won’t feel like your premiums are going to waste.
If you find a better use for the cash value of your policy or believe it isn’t performing as you expected, you can also cancel and receive most of your premiums back. However, there are usually surrender charges if you cancel within the first 10 years of the policy.
Indexed universal life insurance with a critical care or accelerated death benefit rider
Some cash value life insurance policies have low-cost or no-cost riders that allow you to access most of the policy’s death benefit for long-term care. If you’re healthy, these policies can be funded to provide better cash value and more death benefit than hybrid policies. The cash value of indexed universal life insurance grows based on the returns of a particular index like the S&P 500.
Most policies have a floor of zero to 1% and a cap rate of around 10% to 15%. If your cap rate is 13% and the S&P 500 goes up 30%, you would make 13% that year. But if the S&P 500 loses 40%, the floor prevents you from losing money. You won’t receive the dividends you would if invested directly in the market.
This policy’s potential growth could make it your best option if you care more about your cash value and death benefit than about having the largest pool of funds available for long-term care.
Comparing three options
I gathered the following quotes to show a healthy 62-year-old woman how these three policies would compare when she’s 80 and might need long-term care. For each category, I used a top life insurance company that provides the most benefit for the premium paid. Keep in mind that the numbers would be different at every age.
For the indexed universal life policy, I assumed that the average annual return would be 6%. Remember, the actual return will fluctuate between a floor and a cap. As you can see in the table, there are two values for both the death benefit and cash value: One is the guaranteed value, and the other is a projected value based on the expected average return. It’s good to separate the categories to show the range of possibilities. Some people shopping for insurance will want to use the more conservative guaranteed values for planning purposes, while others would like to see how their policy might grow.
|Traditional long-term care insurance||Hybrid life and long-term care insurance||Indexed universal life insurance (run at 6%)|
|Long-term care benefit pool at 80||$355,809||$385,746||$244,522|
|Your access||$4,937 per month||$4,970 per month||~$61,000 per year for four years|
|Death benefit at 80||N/A||$91,482||$244,573|
|Guaranteed death benefit at 80||N/A||$91,482||$155,386|
|Cash value at 80||N/A||$64,424||$130,853|
|Guaranteed cash value at 80||N/A||$64,424||$41,666|
|Premiums paid by 80||$67,952||$80,530 (over 10 years)||$80,530 (over 13 years)|
Each option has different strengths and weaknesses. You tend to get the most long-term care benefit for the least cost with traditional long-term care insurance. Hybrid long-term care insurance has the benefit of very simple underwriting, and policyholders get a good amount of care for the amount they pay, with the bonus of a death benefit. Indexed universal life is likely to provide higher cash values and a better death benefit, but gives you the lowest long-term care benefit.
Think outside the box
There are a variety of ways to plan for the potential costs of long-term care, and each has its pros and cons. But if you decide not to self-insure, don’t be afraid to think outside the traditional long-term care insurance box. Compare different carriers and types of policies to find the one that best meets your needs.
This article also appears on Nasdaq.