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Life Insurance and Annuities: Alternatives to Pay for Long-Term Care

Among the many ways of paying for long-term care, life insurance and annuities have been growing in popularity.

Life Insurance

In its original form, life insurance was intended only to pay beneficiaries upon the death of the insured. Since its inception, however, life insurance has evolved to include many additional options. Some of these options can help pay for long-term care.

Option 1: Leveraging Cash Value

There are two types of life insurance: term and permanent. Term most resembles the original form of life insurance. It simply pays out a benefit at the time of death. Permanent life insurance also pays out at death, but unlike term, it also has a cash value component that builds up during the life of the policy.

The owner of a permanent life insurance policy can leverage cash value to pay for long-term care in three ways:

  • Surrendering the policy to get the cash value
  • Taking a loan on the policy in which the cash value serves as collateral
  • Selling the policy to a third party such that the new owner becomes the beneficiary

There are pros and cons to each alternative. Consult with a trusted financial advisor to fully understand the implications of each before making a decision.

Option 2: Accelerated Death Benefit

An accelerated death benefit (ADB) allows the insured to access the policy payout prior to death. Often included as a standard feature on both term and permanent life policies, some ADBs can be activated to help pay for long-term care costs. Therefore, when shopping for life insurance, consumers should pay close attention to ADB provisions in the contract. Insurers differ on what criteria will trigger an ADB payout and whether the payout is a lump-sum or monthly payment.

Option 3: Hybrid Policies

A hybrid policy (also called a linked benefit policy) directly combines a life insurance policy with a dedicated long-term care policy. The linkage exists because the long-term care benefit amount is tied to the premium amount paid in. For example, a $75,000 lump-sum premium payment would result in $375,000 in long-term care benefits depending on specific policy contract language. Premiums paid into the policy are split between the cash value account and the cost of the insurance.

Option 4: Long-Term Care Riders

A long-term care rider is another method to deliver long-term care benefits via a life insurance product. A rider is an optional policy benefit that usually increases the cost of the policy to cover additional benefits. In this case, the rider acts the same as the long-term care insurance component of a hybrid life policy.

For both the hybrid and rider, the insured begins receiving benefits upon meeting medical standards for needing long-term care such as an Alzheimer's diagnosis. Also, a death benefit would be payable upon the insured person's passing. The amount of the death benefit would be dependent on the amount in long-term care payments that were disbursed.

This is the defining advantage of the life insurance plus long-term care combination. A common criticism of dedicated long-term care insurance is that if the insured never needs long-term care, the premiums paid are wasted. With a life insurance base, the death benefit compensates to some degree for the premiums paid.

While they aim to provide the same sort of benefit regarding long-term care, the key differences between a dedicated LTCI policy and long-term care benefits provided within a life insurance policy are outlined below:

Dedicated LTCI Hybrid Life Policy or Long-Term Care Rider
The only purpose of the contract is to provide long-term care benefits. The life insurance policy provides a death benefit as well as long-term care coverage. However, any long-term care benefits paid reduce the death benefit amount.
Monthly premiums can increase. The cost of premiums is usually fixed.
Once premiums are paid in, they cannot be refunded, even if the insured never uses the long-term care benefit. The policy death benefit provides some "payback" for premiums paid by the insured.
The intended insured must pass a medical exam prior to policy approval. A medical exam tends to be less stringent than for dedicated LTCI.
LTCI is only insurance. It has no underlying cash value. For permanent life policies, cash value increases on a fixed or variable basis.

Given all the differences, how should these two alternatives be analyzed? A good way to make an apples-to-apples comparison would be to match a hybrid life policy or policy with a long-term care rider to a stand-alone LTCI policy and a stand-alone permanent (cash value) life policy.

Annuities

Annuities pay a monetary benefit as long as the annuitant (annuity owner) lives. It can be an immediate-type which means income flows to the annuitant soon after the initial lump-sum payment into the annuity. For a deferred annuity, income starts at a future date. Like the cash value component of a life insurance policy, interest on money put into the annuity grows at either fixed or variable rates.

Annuities designed for long-term care are the deferred type with a long-term care rider. The advantage of these annuity riders is if the long-term care benefit is not used, the annuitant still receives guaranteed income. So, like the life insurance version, premiums targeted for long-term care are not "wasted." Also, like life insurance, medical exam requirements tend to be less stringent.

A major disadvantage of the annuity rider alternative is the upfront, usually large payment may be out of the question for many consumers. However, for existing annuity holders, a tax-free 1035 transfer can the made to a long-term care-oriented annuity. Payments from the new annuity for long-term care purposes are also not taxable.

Attractive, But Complicated

Despite some attractive advantages for some consumers, buying insurance or an annuity for long-term care can be a complicated process. It's helpful to work with a trusted and knowledgeable professional to sort through all the options.

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