Your clients may have chosen to retain the risk and responsibility of funding future long term care costs. While it may appear that they can financially afford to do so, is this strategy prudent? Is this plan consistent with their retirement portfolio objectives? And can a long term care event be absorbed soundly within their existing portfolio?
A risk management tool
If not, then consider LTC insurance as a risk management tool that can help protect clients’ assets and enhance the probability they will meet their portfolio objectives.
It is a life insurance professional’s responsibility to help clients recognize that LTC insurance is an important of part of a retirement portfolio. Increased media attention is helping to educate on the rapidly rising cost of long term care and the growing importance of being financially prepared for this potential expense. LTC insurance can transform a potentially huge negative impact on one’s assets (e.g. the cost of a LTC event) into a manageable stream of premium payments, transferring this risk to the insurance company.
Though a client may understand the risk management advantages of owning a LTC insurance policy, an objection I frequently hear is that retirees do not want to have the burden of paying the policy premium indefinitely into their retirement years. However, clients can dedicate a portion of their retirement assets–allocating a part of their retirement portfolio now–to cover this risk. How can this be done? Read on…
Lifetime income annuities
Many high-net worth clients diversify their portfolios by investing in a combination of money market accounts, stocks and bonds. Over the past two years, lifetime income annuities have also become an increasingly popular staple of a well-diversified retirement plan.
The products provide income for life or for a specified term. This further diversifies a portfolio by helping protect the client from longevity risk (the risk of outliving one’s money.) Moreover, the benefits are calculated off of a one-time premium payment, eliminating the burden of regular contributions.
You can extend this technique to allocate a portion of retirement assets to LTC needs, while reducing the large contingent risk associated with doing it yourself. Thus, you can use a lifetime income annuity to fund future LTC insurance premiums. You cannot guarantee that you will cover all future premiums (since LTCI premiums are not guaranteed) but you can cover most reasonably expected premiums.
Consider John, a 65 year-old client, who is retired and wealthy. John purchases a lifetime income annuity for $500,000 that would produce a monthly payout of $3,009, which would be $2,749 after taxes for the duration of his life. (Only a portion of the GLI payout is taxed. Example assumes that the client is in the 28% tax bracket.)
If John were to purchase a LTC policy, with 100% in-home care, a $300 daily benefit for a 5-year term, and an inflation rider (a guarantee to adjust to the Consumer Price Index annually at no additional premium cost), it would cost him approximately $691 monthly.
John can direct a portion of his lifetime income annuity payments to pay the LTC insurance bill. By doing so, John avoids the burden of another expense. He preserves his estate in the case of a LTC event and has inflation protection.
For 5 years of coverage at $300 a day, John would receive a maximum benefit of $547,500. The maximum value of his benefits is worth more than his initial income annuity purchase of $500,000. Note that because of the inflation rider, his maximum benefit could continue to increase each year. Moreover, even after diverting $691 a month to fund the LTC insurance, John still keeps $2,059 a month or about $24,702 annually after tax.
A second scenario
Now suppose John selects an unlimited LTC policy with $300 daily benefit or keeps the term of his policy at 5 years, but increases the daily benefit to $400 a day. These benefit selections would both potentially give him greater LTC benefits and would cost approximately $969 a month for the unlimited plan with $300 daily benefit or $921 a month for the 5-year plan and $400 daily benefit. After funding this from the lifetime income annuity, John still keeps approximately $1,781 a month with the unlimited plan or $1,828 a month with the 5-year $400/day plan, both on a post-tax basis.
By using a lifetime income annuity to fund a LTC insurance policy, you have also matched the duration of John’s expense burden with his income flow. As long as John is living, he will receive lifetime income annuity payouts and, therefore, will likely always be capable of funding the LTC premium. If John goes on claim for a LTC event, he would stop paying the premium and keep all of the income annuity’s payout.
In this situation, John’s lifetime income annuity was only for the duration of his life. If he passed away tomorrow, the value of that income annuity would go with him.
Now let’s assume that John purchases a lifetime income annuity with a 30-year period certain, so if he passes away tomorrow, his estate would still receive income from the annuity. Switching from a life to a 30-year certain term changes the monthly payout to approximately $2,322 a month (pre-tax) or a guaranteed lifetime income of approximately $835,920 pre-tax.
John can still afford the LTC policies described above and receive all aforementioned benefits. Additionally, he is potentially passing on a larger inheritance to his estate (the remainder of the 30-year payouts under the lifetime income annuity minus cumulative LTC insurance premiums that had been paid).
Weighing the opportunity cost
Although LTC insurance is not typically thought of as an asset, its ownership can be exchanged for eligible LTC services. Even if your clients have the ability and risk tolerance to self-insure in today’s economic market, clients should consider the opportunity cost. In the absence of LTC insurance one might have to sell off assets or borrow from an investment or retirement account.
Rather than earmark a hefty amount of capital to support a possible LTC event in the future, clients can transfer the risk to the insurance company and use a lifetime income annuity to fund insurance premiums. By doing so, they reduce retirement portfolio risk and can use remaining income and assets to support a quality of life to which they are accustomed.
As one cannot predict if a LTC event will occur, it is extremely important for wealthy clients to complete the last step in their retirement plan: consider purchasing an LTC policy. There is no better time to be sure your clients’ retirement plans are complete.