All clients know that the costs of post-retirement health care are rising, making planning for these expenses critical to financial security in retirement. It’s perhaps more important for advisors to remember that health expenses will impact all clients during retirement—even high net worth clients who may frequently overlook the need to plan for post-retirement health expenses.
When the costs of long-term care are factored in, studies estimate that those nearing retirement could need as much as $400,000 to cover post-retirement health expenses. Because high net worth clients are unlikely to ever qualify for means-based Medicaid coverage, a tax-efficient strategy for covering these expenses can be even more important—and permanent life insurance can provide a creative, tax-preferred savings bank that is particularly attractive to the affluent client.
Rising Post-Retirement Health Costs
Even when clients specifically plan for post-retirement health expenses, many fail to account for all of the health-related expenses that they are likely to encounter. Premiums for Medicare Parts B and D (prescription drug coverage) and supplemental coverage are only the tip of the iceberg for may retirees—and for high net worth clients, the costs of these premiums are subject to increase based on income levels. When the “Doc Fix” law becomes effective next year, the highest earners will pay even more in Medicare premiums.
What clients often overlook are the expenses that are not covered by Medicare. Coverage for dental and vision care is limited, and most of the costs associated with long-term care are not covered by Medicare at all. Further, expenses that are not strictly medical—such as the cost of home assistance—often must be funded out-of-pocket.
The Life Insurance Funding Strategy
Several types of cash value life insurance exist, but the basic concept is the same: the client pays in premiums to the policy over his or her lifetime that, over time, are invested by the life insurance carrier and provide a build-up of cash within the policy. Whole life insurance policies generally come with a fixed premium level, while universal life insurance often offers flexible premiums.
When using life insurance as a heath expense funding bank, it is important that the client have sufficient funds to continue paying premiums on the policy over time. In fact, the client may wish to consider over-funding the policy (paying more than the required minimum premium) to speed the growth of cash value in the account.
Over time, the cash value in the account will grow based on the interest (or dividends) credited to the client’s account. Indexed universal life insurance policies, for example, are tied to a specific stock index—such as the S&P 500—and provide returns based on market performance. These policies often come with both an earnings cap and an earnings floor, so that, for example, the policy might earn no more than 15 percent, but no less than 2 percent, meaning that the policy can continue to grow even in an economic downturn.
Once the cash value has built up to a substantial level—over a period of years—the client can begin taking tax-free withdrawals (loans against the policy cash value) to fund post-retirement health costs. If the client dies prematurely, the policy, of course, still offers a death benefit that will be paid out (also tax-free) to the policy beneficiaries.
Clients should also consider exploring life insurance policies that come with chronic care or long-term care riders that speficially provide for certain benefits in the event that a chronic illness or the need for institutionalized long-term care arises. Benefits paid out under the riders will reduce the eventual death benefit, but if the care is never needed, the entire amount will pass to policy beneficiaries.
Post-retirement health expense planning is one area that often requires creativity in crafting the most effective and tax-efficient strategy. Using permanent life insurance as a funding mechanism is one potential solution that high net worth clients should consider.