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A Better Alternative to Self-funding Long Term Care Expenses

 

There are a lot of people who figure they will just “self-fund” any long term care expenses that may come up in the future. These folks typically fall into one of several categories:

  1. They have a modest estate—maybe $500,000 to $1,000,000. They take a look at the worst case scenario—having to go into a nursing home at (today $70,000 per year, but varying by location)—and use the average nursing home stay (2-5 years, depending on who you are talking to) and go on to figure they can self-fund $350,000 with no problem.
  2. They figure they are too old and the premium would be prohibitive.
  3. They have health issues that may make them uninsurable or push the premium through the roof.
  4. They have mega bucks. They could buy the long term care facility and stay in it for free.

However, in all these situations there is a low cost, risk-free way to cover the long term care base. Let’s take a look at a typical situation.

Bob and Mary Ann have the modest estate, as noted above. They are in their late 60’s. Mary Ann has Type I diabetes. They do have a concern about eventual long term care, but have rationalized it away by assuming that at their age the premium would be too high (probably true). With Mary Ann’s diabetes, they doubt if she is even insurable (probably also true, and if so, they don’t want to know the premium to cover her if either of them have heart conditions).

Bob has a $200,000 annuity that’s just sitting there. They figure they would just tap into that for any long term care needs.
That very well may fit the bill if they apply the average long term care costs outlined above. But today, there is a bigger risk: Alzheimer’s. They know it and it scares them half to death. They know they could be in great health, develop Alzheimer’s, live for many more years with the assistance of expensive care and consume their entire estate.

So let’s take a look at one thing they could do…

Long Term CareThere are a few insurance companies which offer an annuity/long term care combination plan. So Bob could simply do a tax-free 1035 exchange and move his $200,000 traditional non-qualified deferred annuity to a plan like this.

The annuity would function just like the one he has owned for a number of years. Each year the insurance company would declare an interest rate for the following year, the funds would continue to accrue on a tax-deferred basis, etc, etc.

If Bob needs long term care of any type (respite care, hospice care, adult day care, home health care, assisted living or nursing home care), he can withdraw funds from the annuity over a maximum three year period at the rate of $2,900 a month for every $100,000 his annuity has grown to. So with a $200,000 annuity, he has about a $70,000 a year benefit from the get go.

All this is not too much different than Bob withdrawing from his current annuity. So why do the 1035 exchange? Here is the reason. In fact, in my opinion this is the reason to do the deal in the first place…

At least one insurance company will allow Bob to add a rider to this annuity that extends his long term care benefit for life. Keeping his annuity as is or making the exchange has him covered for about three years either way. But being able to get coverage for life is big time.

The second reason for making this exchange is that the premium for the life time coverage is very low. The reason is that it doesn’t kick in for three years. That’s like having a three year waiting period instead of the usual 60, 90 or 120 days. Longer waiting period; lower premium.

The third reason is that for folks who may not be able to qualify for a traditional long term care policy because of health issues, this approach doesn’t require a medical exam. Not everyone will qualify, but the underwriting is many times more lenient.

The fourth reason is that Bob can put Mary Ann on this lifetime plan—even though it was Bob’s annuity that was transferred. And remember, she’s the one with Type-I diabetes. They would have to self-fund, as they planned to do anyway, for the first three years, but she then has coverage for the rest of her life so they are protected against the big hit.

The final point is the subject of a different article. After 12/31/09, the Pension Protection Act of 2006 allows money taken out of the annuity in this example to pay the premium for the lifetime coverage to be free of income tax. Today, any money withdrawn from an annuity is treated as a gain, to the extent there is a gain, and taxed at ordinary income. So after 12/31/09, the plan described here could be internally self-funded with no adverse tax consequences.

If you have a situation anywhere near Bob and Mary Ann’s, I would suggest not waiting until 2010. Many insurance companies are making transition plans now. Sit down with your financial planner and explore your options.

 

 

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