When producers identify a client’s need for permanent life insurance and the possibility for additional tax-preferred income in retirement, the concept of an insurance-based retirement plan (IBRP) becomes logical to consider. However, when producers want to use an IBRP to provide supplemental retirement income, they seldom think of long term care needs in conjunction with this type of plan. Why?
In my opinion, because:
o The producer is suggesting an IBRP to a young professional looking for life insurance protection and additional ways to invest tax-preferred dollars. The producer may assume the typical IBRP prospect is in an age bracket not interested in discussing LTC needs;
o The producer may understand the value of an LTC rider, an option available at an additional cost, but might assume the cost of insurance on the rider could greatly impact the cash value (therefore the income) of the IBRP. The producer also may believe the LTC rider is not worth adding, with the possibility of paying for something the client may never use; and
o The producer may not realize how an LTC rider works with employee-owned plans. And he or she may not understand the value such a rider could add to an executive bonus 162 plan, a collateral split-dollar plan or a simple IBRP.
It may help to begin with some information about the need for LTC. Some sources estimate at least 50% of Americans will need LTC during their lifetime. Of this group, about 15% will end up in a nursing home. The remaining 85% will need some variety of home health care, assisted living or adult day care.
While the costs of these services seem less expensive than nursing home care, keep in mind the following facts:
o The average stay in a nursing home is 2.5 years, with the average annual cost of nursing home care in 2005 being $62,532 for a semi-private room;
o The need for care outside of a nursing home averages 4.5 years, but a significant segment of the population will need care for five years or longer;
o The average annual cost for an assisted living facility is $32,294;
o The average home health care costs are running more than $22 per hour; and
o LTC costs are expected to quadruple by 2030.
While the typical IBRP prospect is not thinking about LTC needs, the statistics above show that some thought into these needs should be addressed and planned for. It has been suggested that people with assets between $100,000 and $1.5 million need some form of LTC protection. The addition of an LTC rider to an IBRP makes sense for several reasons.
The LTC rider makes a great beginning to LTC planning, in that “something” is in place that allows a tax-free collection of a death benefit should an unforeseen tragedy occur while the insured is still young, or becomes uninsurable in later years before LTC needs are more formally addressed.
A more compelling reason is the opportunity to enhance the income value of the IBRP. The LTC rider is less expensive to add to an overfunded life insurance policy due to a smaller net amount at risk; the rider, therefore, has an insignificant effect on the income stream available in retirement years.
The IBRP contract with an LTC rider will average about 2% less income per year than a contract without the rider. However, should your clients actually need long term care–and some statistics show there is at least a 50% chance they will–having an LTC rider could allow for a significant amount of additional money to be pulled from the contract. How much would depend on when long term care was needed compared to when income was taken.
The LTC benefit is paid via an accelerated death benefit–not withdrawals or loans. While the insured is receiving the LTC benefit, no loans or withdrawals can be taken from the contract, so the cash value may continue to grow.
Withdrawals from the contract will not affect the LTC benefit, so until the contract has exhausted the cost basis, the LTC benefit will still be intact. Once loans begin, the LTC benefit available will be reduced dollar for dollar by the loan balance.
The LTC rider can provide additional value to employee-owned supplemental retirement plans, including executive bonus 162 plans and collateral split-dollar plans. The LTC rider benefit is normally paid to the owner of the contract. Since the employee is the owner in such plans, this rider is an appropriate addition that is easy to implement.
How the plan is built
The IBRP is an overfunded contract with several design options. For example, the client purchases an overfunded life insurance policy with $1 million of death benefit. Based on the premiums paid, this IBRP is designed to pull out about $120,000 per year in income. The LTC rider benefit is the lesser of 2% of the specified amount, or the daily HIPAA rate times the number of days in the month, and is paid tax-free (the daily HIPAA for 2006 is $250 per day or $90,500 per year).
Adding a $500,000 LTC rider would provide $10,000 per month in LTC benefits, which equals the income that was planned, assuming the current annual HIPAA limits will increase at the rate they have been experiencing in recent history. If the insured were to become eligible to receive LTC benefits prior to the loan balance eliminating the entire benefit, there would be more total dollars paid out.
Results will differ depending on when the LTC benefit begins. One can take income over a period that will accumulate a loan balance that reduces or eliminates the LTC benefit. The LTC rider benefit is the lesser of the rider-specified amount or death benefit minus the loan balance.
A real-life case study
Let’s consider an executive named Andrew, a 47-year-old nonsmoker in preferred health. Andrew decided he needs to save additional funds for retirement and has maxed out his other tax-deferred opportunities. Andrew believes he will work another 20 years. He also has a life insurance need of about $1 million.
His investment professional suggests he use an IBRP as the next best opportunity for tax-preferred savings. The investment professional also suggests to Andrew that he consider adding an LTC rider to the policy. Andrew, being relatively young and assuming the costs of the rider would take away from his cash value, is hesitant to add the LTC feature.
The investment professional shows Andrew the following illustration:
It is assumed that Andrew will work until age 67 and, upon retirement, begin taking income from other retirement assets first. When he reaches age 72, Andrew will plan to start taking income from the life insurance contract. The illustration also assumes the current annual HIPAA limits will increase at the rate they have been experiencing in recent history.
Using the LTC rider in conjunction with the IBRP in this example allows for an extra $332,367 to be distributed from the policy, assuming death occurs at age 86. Should death occur at a later age, the difference could be even more substantial.
In this example, if Andrew lives to be 100, without the LTC rider included in the IBRP, the total payout would be $1,673,425. However, the IBRP with the LTC rider included would provide a payout at age 100 of $2,676,081, which is an additional $1,002,656.