Making sure you have enough money set aside for retirement is about more than just calculating your annual expenses. You also have to consider the costs associated with losing your independence as you age. If you want to have a stable retirement, you would be wise to plan for the possibility that you may need long-term care when you are no longer able to care for yourself fully.That’s because long-term care costs can be overwhelming to a retirement budget. The national average daily cost of a nursing home is $225, according to 2016 data from the U.S. Department of Health and Human Services. Combine that with the average nursing home stay totaling 272 days, based on findings from a 2017 study conducted by RAND Corporation, and you can expect to spend over $61,000 on a single, average-length nursing home stay ($225 x 272 days = $61,200). Unfortunately, Medicare does not generally cover nursing home stays or help with daily living, so this kind of expense falls on the retiree.
Traditionally, there were only two ways to handle the potential costs of long-term care in retirement: paying out of pocket or purchasing long-term care insurance. But long-term care annuities can give you another alternative for planning for your long-term care in retirement.
Here’s what you need to know about long-term care annuities and how to decide if they fit into your plans for your future care.
Before examining the ins and outs of a long-term care annuity, let’s define the base product – the annuity.
Annuities are sold by insurance companies. The investor pays the insurer a lump sum, and in exchange, the insurer will provide the investor with regular, guaranteed payments. The insurer invests your money and shares some of the investment growth with you via your guaranteed payments. These payments are guaranteed for either a fixed period, or for the rest of your life.
There are two main types of annuities: immediate and deferred.
With an immediate annuity, after you pay your lump sum, you start receiving your payments as quickly as the following month. Since there is no time for your immediate annuity to grow, these products generally cost more than deferred annuities to get the same monthly payment.
Deferred annuities also require a lump sum initial payment, but your payouts do not begin right away, which allows your investment to grow. The time between your initial investment and when you begin withdrawing money is called the surrender period. If you try to take money out of your deferred annuity before the end of the surrender period, you will face hefty fees.
Once you have reached the end of your surrender period, you have multiple options for accessing your money. You can access the lump sum, annuitize the funds – meaning you’ll receive regular payments for life – or you can take systematic withdrawals when you need them until the fund is empty.
Long-term care annuities are deferred annuities with a long-term care rider. This means that these products, like traditional deferred annuities, provide future payments based on an initial lump-sum investment.
However, the long-term care rider offers you some additional financial protection if you need long-term care. “You can expect to see double or triple your investment in a long-term care annuity for long-term care benefits,” according to Susan Kobara, Director of Insurance Services for Global Retirement Partners Advisor Alliance (GRPAA). “In other words, a $100,000 investment in such an annuity would translate to $200,000 or $300,000 worth of long-term care benefits.”
Kobara explained that there are triggering events that allow you to access the LTC benefit. “You must need help with two out of the six activities of daily living (known as ADLs in the insurance industry) to be eligible for long-term care benefits,” Kobara said. “This is also generally true for long-term care insurance.”
The six ADLs are recognized as bathing, dressing, eating, transferring (getting yourself from room to room, or in and out of a wheelchair), toileting (getting yourself on and off the toilet), and continence.
Kobara explained that there is a monthly benefit cap for the long-term care benefit. “Typically, these annuities are structured so that your payout will last about four years at the monthly benefit cap,” she said.
Ultimately, Kobara recommends that anyone interested in an LTC annuity read the potential contracts very carefully to be sure that you understand all of the restrictions and requirements before signing on the dotted line.
Long-term care annuities offer one possible solution for your future care needs. But Kobara warns that long-term care annuities are not necessarily the right product for young and healthy individuals. She explains that those in good health will generally get more bang for their buck with either long-term care insurance or a life insurance policy with a long-term care rider. But if you have certain pre-existing medical conditions, you may find that a long-term care annuity is a good solution.
“The underwriting on LTC annuities is less stringent than it is for long-term care insurance, but there is still some medical underwriting with an annuity and your insurer reserves the right to get your medical records,” Kobara said. “For example, someone with arthritis who has had two knees replaced may be a good candidate for this product, since they may find it difficult to qualify for traditional LTC insurance.”
It’s important to remember that purchasing a long-term care annuity ties up a large sum of money all at once. While long-term care insurance has been getting more expensive over the years, it is set up as a monthly premium payment like other types of insurance. You may find it easier to pay the $3,490 per year (on average for a couple in their 60s) in LTC insurance premiums, according to 2018 data from the American Association for Long-Term Care Insurance, than try to scrape together a larger sum to purchase an LTC annuity.
However, if you end up being able to live independently for the rest of your life, you will have lost out on all of the money you paid in premiums to long-term care insurance. With your long-term care annuity, on the other hand, you will still be able to access the payments from the annuity even if you never need the long-term care benefit.
Long-term care annuities also have complex tax implications, which you may need to discuss with your tax professional. When it comes to taxation, annuities can either be qualified or non-qualified.
Qualified annuities are funded with pre-tax dollars, similar to a tax-deferred retirement account like an IRA or 401(k). However, that means your payments from a qualified annuity are taxed as income, just as the distributions from your tax-deferred retirement account are taxed.
Non-qualified annuities are funded with money you have already paid taxes on. But this does not mean that you don’t pay taxes on your payments, since you will still owe taxes on your annuity investment growth. Payments from non-qualified annuities are taxed based upon your exclusion ratio, which takes into account your principal, the length of time your annuity has been growing, your interest earnings, and your life expectancy.
It is important to understand how your payments, withdrawals, or payments to a beneficiary upon your death will be taxed so you can be prepared for Uncle Sam’s requirements.
Deciding between traditional long-term care insurance and a long-term care annuity will depend on a number of factors, including your health, your available assets, tax implications, and the importance of having your money available to you if you don’t need long-term care.
The most important thing is to plan for the possibility that you will need long-term care, so you are not caught off-guard with a five-figure nursing home bill.