Retirement income planning can be like hitting a moving target in the wind. The target keeps moving because you do not know when you will retire, how much money you will need, or how long you will live. The wind is there because there is not an exact straight line path to get to your retirement target as laws will change, interest rates will go up and down, financial markets will rise and fall, and a variety of uncertain risks could impact your plan. One specific risk that can derail a retirement plan is long-term care. While most retirees will need some long-term care during their lives, it is hard to determine how much care one will need, how expensive the care will be, and how to fund this unknown cost.
Long-term care is a topic that most people do not want to discuss. Indeed, it can be challenging to discuss your own declining health and mental capacity. Nonetheless, for most people this is an inevitable fact of life. Nearly 70% of all people who live to age 65 will require some sort of long-term care in their lives. According to the Genworth 2016 Cost of Care Study, the national median cost of long-term care in a semi-private nursing home is $82,125 and is expected to increase by 3.12% per year over the next 5 years. However, some states, like Alaska, Delaware, Hawaii, Maine, Maryland, New Jersey, New York and Massachusetts can cost well over $100,000 a year.
In order to help cover the costs of long-term care, one should set up a long-term care plan well in advance of retirement. Perhaps the three most important aspects of long-term care planning are that family members tend to provide most of the care, care is expensive, and that long-term care insurance is not the only funding mechanism. Long-term care planning necessarily entails a discussion with family and friends about the type of care you want, where you wish to receive care, and how you will pay for it. In effect, long-term care planning is about giving family members permission to seek out help for you in the event of a long-term care event. Long-term care expenses can be paid for out of pocket, through the purchase of a long-term care insurance contract, through government programs (Medicaid), or through other hybrid financial service products that combine the benefits of life insurance or an annuity with long-term care insurance. Additionally, other types of deferred income annuities, including qualified longevity annuity contracts (QLACs), can help retirees meet their long-term care funding needs.
So how can annuities be used to help fund long-term care needs? First, it is important to understand that there are a tremendous variety of annuities on the market and not all of them will be suitable for every situation, including funding long-term care expenditures. For example, immediate annuities, while very useful in retirement, will not necessarily have any specific benefits to help fund long-term care costs.
Annuities can be strategically utilized to help fund long-term care expenditures through the use of deferred annuities, QLACs, 1035 exchanges, and hybrid long-term care annuity products. One way to help fund long-term care expenditures is to stagger or layer on deferred annuities. This can enable the retiree to create various levels of income for different periods of retirement. For example, you could purchase a deferred income annuity that starts are age 80 and another that starts at age 90. Now while these annuity payments will not perfectly match up with the required long-term care expenditures, they will provide increased income near the time when most people need to fund large long-term care expenditures. In many ways, this is just a form of matching liabilities to assets by setting aside money in a deferred annuity to provide income during a period of high long-term care risk.
One specific type of deferred annuity that can be an interesting source of funding for long-term care expenditures is the QLAC. In 2014, the U.S. government adopted new rules allowing for the use of QLACs inside of 401(k)s and IRAs. These specialized, but limited, deferred annuities can help retirees avoid required minimum distributions at age 70½, increase their retirement income, provide a hedge against longevity risk, and provide a source of long-term care funding. The QLAC is a powerful tool for long-term care funding because it can be purchased inside of an IRA or 401(k), where most retirees house their retirement savings. Additionally, the rules allow the QLAC to stay in the IRA without payments until age 85, at which time payments must begin. However, this can provide a very nice income source for retirees to help fund long-term care expenditures.
Another strategy is to use a so-called hybrid or linked benefit contract, which combines long-term care coverage with an annuity into one product. Some annuities now offer tax qualified long-term care benefits which enable you to invest the money you have saved for long-term care into a product that provides a fixed income but also will provide higher payouts if you need long-term care benefits. In some cases, these types of products will double or triple the annuity payment when long-term care is needed. Additionally, these products can be purchased with a single lump sum payment, which might be preferable to long-term care insurance which generally requires life-time payment of premiums and the possibility that premiums will rise significantly. Annuity hybrid products also solve the use-it-or-lose-it problem with long-term care insurance. If the long-term care benefit is not needed, some annuity payments are still made and those payments can be used for other retirement needs.
If someone already owns an existing annuity or life insurance contract, a 1035 exchange might be a possible way to purchase a different annuity or a hybrid annuity product to help with long-term care expenditures. The Pension Protection Act of 2006 allowed for 1035 exchanges of traditional life insurance and annuity products into hybrid long-term care policies. For example, a life insurance policy could be 1035 exchanged for a hybrid annuity long-term care policy without having to pay taxes on the buildup of value inside of the life insurance policy. Additionally, an existing annuity could be exchanged for a hybrid product or another type of annuity to better meet the long-term care funding plan of the individual without any current tax issues. Ultimately, this can be a very efficient way of strategically using existing products to provide some level of long-term care funding.
When using an annuity or long-term care hybrid product as part of a long-term care funding plan, it is crucial that the decision works in harmony with the individual’s comprehensive retirement income plan. Also, make sure the product fits the individual’s unique needs and goals as every product will not work for every person and situation. Funding long-term care needs as part of a retirement income plan can be challenging, but annuities can be a great ally when utilized correctly and in an integrated manner.
by Jamie Hopkins |
Author: Jamie Hopkins
Source: Forbes Media LLC
Retrieved from: www.forbes.com