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Silver Tsunami Coming For Boomers

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There is a silver tsunami coming; 10,000 people are turning 65 every day, a phenomenon that will happen for the next sixteen years. Living longer than expected, which is often referred to as longevity risk, can increase the likelihood of other risks occurring, driving up certain retirement expenditures such as long-term care costs.  This tidal wave of baby boomers will someday soon need long-term care.

When planning for retirement, clients often list long-term care as a primary concern. However, very few people have well defined plans for dealing with related expenses. The financial cost of long-term care is incredibly expensive, with the average U.S. semi-private nursing home room costing roughly $85,000 a year.

A basic problem for clients looking for long-term care insurance today is that they simply may not be able to find it. Major carriers have pulled out of the market in the last year, and the policies that remain can be prohibitively expensive and contain strict qualification requirements.

One of the things that can discourage people from buying long-term-care insurance is the idea of paying a lot of money for a policy that with any luck they’ll never have to use. Of course, almost all insurance is like that. But long-term-care insurance is particularly expensive and frequently, its purchase comes at a time when people are facing retirement and looking for ways to cut back.

Hybrid or linked-benefit products now allow for long-term care insurance and annuity products. These products can help cover multiple risks for one client through one product, simplifying the planning process. They also can alleviate the “use it or lose it” concerns many people have with long-term care insurance as some of the premium goes to fund another benefit, either annuity payments or a death benefit, in the event they do not need long-term care.

One way to avoid spending a lot of money directly on a long-term-care policy while still getting its benefits is to buy an insurance policy with a long-term-care rider. These hybrid policies work variously, but the type that has gotten the most attention is a long-term-care annuity. Beginning in 2010, the IRS will let those who hold one of these deferred annuities use the money to pay for long-term care free of federal taxes.

A Hybrid life care annuity is a bundled insurance product comprised of a life annuity and long-term care insurance. The life care annuity—the integration of the life annuity with long-term care insurance coverage—is intended to deal with major problems in the currently separate markets for life annuities and long-term care insurance. Some recent studies find the two risks – longevity risk and long-term care risk – to be opposing and thus life care annuities is advantageous in regard to pooling the two risks.

Hybrid annuity products that combine the estate and income planning features of an annuity with the protection of long-term care insurance are becoming increasingly popular among clients looking for replacement insurance. Because the available long-term care benefits under these contracts are based on a percentage of the annuity premium value and often offer optional inflation coverage, clients may need to triple their initial investment to ensure long-term care needs are met, but with the added bonus that those funds are not lost if care is never required.

A “Hybrid” annuity product features an annuity combined with a qualified long-term care insurance rider. It provides financial protection for retirement assets by offering benefits for a potential long-term care event. The long-term care benefits are typically a multiple of your initial investment. In other words a $100K investment in to the annuity can almost immediately be worth up to $300K in long-term care benefits.

Most people will get better coverage if they buy a stand-alone long-term-care policy. But the combination products appeal to people who prefer the flexibility of being able to finance long-term-care coverage if they need it, or to use the policy for other expenses.

Under this combination design, the insured can simply reposition assets into an annuity and receive growth on principal as well as long-term care protection. In accordance with the Pension Protection Act, amounts including investment gains can be paid out as tax-free LTC benefits. The insured maintains the account value and death benefit within the annuity to the extent that these amounts are not used for LTC benefits. Any withdrawals taken for purposes other than for qualified long-term expenses will naturally reduce the account value and thus the total LTC guaranteed benefit as well.

Advantages of Hybrid Annuities:

  • If you need long-term care you can receive up to three times the annuity value to pay for your care
  • In many cases underwriting is limited
  • In some case there is no underwriting
  • If you don’t need long-term care, you still receive the benefits of the annuity
  • Can have a guaranteed interest rate
  • Tax-deferred growth
  • Access to your principal through penalty-free partial withdrawals (typically 10% of account value)
  • Ability to create a guaranteed lifetime income stream
  • Provides a death benefit to your beneficiaries that is designed to avoid probate
  • Usually paid with a one- time lump-sum premium payment
  • Conversion opportunities
  • Can be guaranteed benefits for life

How does this strategy compare to a traditional LTCI policy? While premiums paid to fund the traditional long-term care policy will continue over the life of the policy, an annuity contract with long-term care benefits is fully funded when the contract is purchased. The client will not have to worry about meeting the monthly premium payment or potential future increases in that premium.

Further, while a long-term care policy provides benefits only if the client eventually does require long-term care, the value of the annuity with long-term care benefits may be withdrawn by the client when the contract reaches maturity or passed on to the client’s heirs in the event that care is not required. Conversely, the client’s investment in a traditional policy is lost if he does not require care.

Annuities allow money to grow tax-free, but the tax man has to be paid when the money is removed. These long-term-care annuities free holders from this obligation.

Purchasers put money — $50,000 is about the minimum — into an annuity. Purchasers then choose the amount of long-term care coverage they want, usually 200 percent or 300 percent of the face value of the annuity, and they decide if they want inflation coverage. They also have to decide how long they want the coverage to last, usually two to six years. Inflation coverage will affect the maximum duration of the plan.

Most hybrid deferred annuities operate this way: A long-term-care annuity. You buy an annuity with a lump sum and can use double or triple the premium amount as your long-term-care benefit. A $100,000 investment could provide up to $200,000 or $300,000 in long-term-care benefits. If you choose the $200,000 coverage with a four-year benefit period, the monthly benefit would be $4,200. The LTC Payments within the combo policy are comparable to a stand-alone policy with similar benefits.

If you need the coverage, the value of the benefit is subtracted from both the annuity’s value and the coverage’s value. After a person uses $4,200 for a month in a nursing home, there would be $195,800 left in long-term-care benefits and $95,800 left in the annuity. In the past, the policyholder would pay tax on the amount transferred from the annuity to long-term care. If the policyholder uses up the entire annuity, he or she would still have long-term-care benefits left.

Example: A 60-year-old purchases a $50,000 long-term care annuity with 5 percent inflation protection compounded annually with a 200 percent coverage maximum and a six-year benefit period. So, his initial long-term-care coverage maximum is $100,000 — double the premium he paid. (If he had refused inflation protection, then he could have chosen three times the premium, or $150,000.)  If he makes no withdrawals over 20 years at a 3.5 percent compound interest rate, minus administrative fees, he would have — under the 5 percent inflation-protected scenario –$265,330 available in long-term-care insurance. Or a monthly maximum of $3,685.

If this person never needs long-term care, then the annuity can be redeemed for its accumulated value when it matures at 20 years — or it can be left to accumulate further interest and the long-term care policy will remain enforce. When this person dies, his heirs will inherit the greater of the accumulated annuity value, if there have been no withdrawals, or the single premium he paid initially less the amount of long-term care paid.

Many annuity contracts with long-term care riders will provide coverage with significantly fewer qualification requirements than a traditional policy, providing an attractive alternative for clients with preexisting conditions who may be unable to qualify for traditional policies.

Like a traditional long-term care policy, if amounts are withdrawn to pay for the client’s long-term care expenses, those amounts are taken tax-free (regardless of whether they represent the client’s investment in the contract or earnings over the accumulation period).

However, clients should be advised that some of these contracts may take years to fully mature and tie up a larger dollar value over this accumulation period. The contract may permit the client to make withdrawals during the accumulation period, but any withdrawals will reduce the amounts available to the client if care is needed.

Conclusion – Though a hybrid annuity contract may not be the solution for all clients, for those who seek to protect themselves in the event that extended long-term care becomes necessary, finding long-term care benefits through the use of an annuity product may provide a relatively simple-to-obtain and tax-preferred alternative.

The appeal of these products lies in their ability to use leveraged dollars to secure both life and LTC coverage. In the current interest rate environment, it’s a great use for money that’s earning next to nothing in a fixed vehicle such as a CD. What’s more, if the policyholder never needs long-term care, that money stays inside the policy, to eventually pass to beneficiaries on a tax-favored basis. “So you’re not only getting death benefit coverage, you’re getting living benefit coverage.



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Tuesday, February 4th, 2014 Wealth Management

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