Close
ThinkAdvisor

Life Health > Life Insurance

Life insurance as long-term care: Doing double duty

X
Your article was successfully shared with the contacts you provided.

A long-term care (LTC) event may very well be the single most devastating event that could befall your clients in retirement. It can be so devastating that, from a financial perspective, your clients could be better off dying than needing long-term care (and I mean that in the most loving way possible). Here’s how I break this news to my clients:

Me: “Mr. Jones, you know we love you, right?” 

Client: “Yes, I know you love me.” 

Me: “We do love you, but you’re better off dying than needing long-term care. Here’s why: Were you to die, all of your assets (401k, IRA, mutual funds, etc.) would go to your wife who is your beneficiary. And, while we would all miss you terribly, Mrs. Jones’ life from a financial perspective would continue along relatively unchanged. However, if you didn’t die but needed long-term care, all of the sudden, much of the money she was planning on using in retirement now gets earmarked for the long-term care facility.” 

At this point Mr. and Mrs. Jones gulp audibly.

Me: “Here’s how it works: Before the federal government will step in to pick up the cost of your long-term care, your estate goes into what we call ‘spend down.’ Your wife becomes the ‘community spouse’ and may be left with just one house, one car, a Minimum Monthly Maintenance Needs Allowance (MMMNA), which in most states averages around $2,500 a month, and around $117,000 of assets. So, what was shaping up to be a pretty rosy retirement for your wife, can now turn into a bare-bones sort of lifestyle.”

By this time their eyes are like saucers and their mouths have drooped into their laps. But it gets worse.

Me: “Now, the same holds true for you Mrs. Jones. Were you to need long-term care, all of your and Mr. Jones’ cumulative assets go into spend down and he becomes the community spouse. He too may have to find a way to get by with only one house, one car a MMMNA of $2,500 a month…etc.”

I take such a direct approach because my clients desperately need to embrace two realities:

  1. There’s a 70 percent likelihood that one of them will need long-term care during their lifetime.
  2. The costs of long-term care can, in a very short period of time, devour a lifetime of savings, leaving the community spouse and their heirs financially devastated. 

If all this is true, why don’t more people have long-term care insurance? There are three main reasons:

  1. High Expense: Long-term care insurance for a husband and wife can be pricey. What’s more, there’s no guarantee that the insurance company won’t raise the premiums down the road.
  2. Hard to Qualify: Qualification for a long-term care policy is based on morbidity (likelihood that you’ll need long-term care), not mortality (longevity). You might very well live to be 120, but if you have a bad back, bad knee, etc., you may not even qualify.
  3. Use it or Lose it: Most people dread paying for something they hope they never have to use. With traditional long-term care insurance, if you die peacefully in your sleep 25 years from now never having needed the coverage, they don’t send you your money back. It goes to pay for someone else’s benefit!

But what if your clients could protect their estate from a long-term care event without all the heartburn of traditional long-term care insurance? More and more Americans are doing so by employing a financial tool known as a Life Insurance Retirement Plan (LIRP).

First, what is a LIRP? A LIRP is a tax-free bucket of money that gets treated under its very own section of the IRS tax code (7702). This section of the tax code allows for the following:

  • Death benefit passes to heirs tax-free
  • Dollars can be distributed pre-59 ½ with no penalty
  • There are no Required Minimum Distributions (RMDs) at 70 ½
  • Contributions grow tax-deferred (no 1099s)
  • Distributions can be tax-free and cost-free through a combination of withdrawals to basis and 0 percent loans on growth
  • Distributions do not count as provisional income (do not cause Social Security taxation)
  • There are no contribution limits
  • There are no income limitations
  • It may enjoy protection from future changes to tax law – when tax laws have changed in the past, existing contracts have been grandfathered

Sounds like the perfect tax-free bucket of money, right? Well, the IRS says that if they’re going to give you the benefit of an unlimited bucket of tax-free dollars, they’re going to require that there be a cost of admission. They’re going to require that there be a spigot attached to the side of that bucket through which flows, on a monthly basis, the cost of term insurance. 

Here’s the problem: If your clients’ house is paid off, and their kids have moved out, term insurance probably isn’t all that high on their wish list. Well, the companies that sponsor LIRPs recognize that, so they’ve done something to sweeten the pot. They simply say that, in the event that somewhere down the road your clients should need long-term care, they will give them their death benefit while they’re alive for the purpose of paying for it.

Here’s an example: Let’s say that Mr. Jones has a $400,000 death benefit and he wakes up one day and can no longer feed himself, bathe himself, transfer himself, etc. (any two of six activities of daily living), and he can find one doctor to write one letter to that effect. At this point some life insurance companies will begin sending him 2 percent of his death benefit (DB) every month for 4 years, or until 96 percent of his DB is consumed. This may be discounted slightly, depending on the age the benefit is received, but the point is this: Some life insurance companies are willing to give policyholders their death benefit while they’re alive for the purpose of paying for long-term care. 

Furthermore, should your client die peacefully in their sleep 30 years from now, never having needed long-term care, someone’s still getting a death benefit. So there isn’t this sensation of having paid for something they hope they never have to use. Either the death benefit gets used during their lifetime for long-term care, or it gets passed along tax-free to the beneficiaries when they die.

What’s more, it may be easier to qualify for the LIRP than traditional long-term care insurance. Because life insurance policy approval is based on mortality, not morbidity, your clients are less likely to be rejected for the back or joint issues that plague many long-term care insurance applicants. 

In conclusion, the LIRP can be an effective, angst-free way to accomplish many of your clients’ most pressing retirement objectives. It allows your clients to accumulate tax-free wealth while protecting them from the financially devastating effects of a long-term care event without the heartburn associated with traditional long-term care insurance.