Today I’m sharing unique alternatives to buying long-term care insurance.
While some people can avoid an expensive insurance policy, everyone needs to have a plan for long-term care (LTC) expenses in retirement.
The U.S. Department of Health and Human Services says that 7 out of 10 people will require some sort of LTC assistance during their lifetime.
The department also notes:
- Women need some sort of long-term care for an average 3.7 years
- On average, men need care for 2.2 years
- One-third of those turning 65 will not need any long-term care during their lifetime, but 20% of that group will need care for five years or longer.
This means that the majority of retirees will need LTC services of one type or another during their lifetime. As you will see below, the cost of this care is expensive.
As such, this cost needs to be part of your retirement planning in order to avoid running out of money and becoming a crippling financial burden on your family.
While it’s not pleasant to think about, long-term care is typically defined as needing assistance with two or more of the following list of ‘activities of daily living’:
- Dressing yourself
- Toileting including related personal hygiene tasks
- Transferring yourself to/from a bed, a wheelchair, or a chair
- Eating and taking medication
- Continence issues
- Cognitive decline (e.g. Alzheimers)
The Biggest Misconceptions About Long-Term Care Insurance
There are a number of common misconceptions regarding long-term care.
“Medicare will pay for everything.”
One common misconception is that Medicare covers these costs. In most cases, Medicare does NOT provide any coverage for long-term care. Neither does regular health insurance.
These policies don’t cover things that typically trigger a claim under a long-term care insurance policy. In other words, you’re on your own.
“My spouse will take care of me.”
This is a BIG ‘maybe.’
What if your spouse is also sick?
What if he or she passes away before you?
What if they are not physically able to provide your care OR you need care that exceeds what can be provided at home?
Just as we hope that you won’t need LTC, we hope that your family will be able to care for you. But luck favors the prepared, so we need to be ready to pay for professional care.
“I won’t need care.”
Hopefully, this is true as NOBODY wants to spend the last years of their life sick and/or in a nursing home. However, what if you DO need care?
While many people can be cared for at home, this isn’t always the case.
As mentioned above, 70% of people will need some form of long-term care service in their lifetime. Without a plan, paying for care could bankrupt you AND your family.
How to Plan for Long-Term Care
We feel that coming up with a plan to pay for long-term care costs is an essential part of any retirement planning strategy.
I was quoted in a 2011 Kiplinger article as follows:
“We talk about risk management with our clients before we talk about how their portfolio is going to be invested. Who cares if you outperform the markets by x% if you lose it all to long-term-care expenses?”
This was true in 2011 and is still how we approach this topic.
As I also said in that interview, there are only three ways to cover these costs:
- You can pay for them out-of-pocket by self-insuring
- You can find a way to qualify for Medicaid (not to be confused with Medicare)
- You can buy long-term care insurance
Medicaid varies by state, but it tends to kick in only after you’ve exhausted other assets that can be used to pay for care. This, of course, has a lot of implications for your retirement lifestyle and other areas such as estate planning.
(Note: Medicaid is jointly funded by the federal government and the state, which is why eligibility and benefits vary by state.)
Looking at the median costs from the Genworth survey, the cost of care can add up to a significant portion of your retirement nest egg.
For example, a retirement saver with Social Security and a $2 million nest egg can live quite well in most cases. However, if they need nursing home care for several years, the cost could easily erode 25% or more of their savings.
Who are the best candidates to self-fund long-term care costs? There isn’t a firm answer here, but some factors we consider in helping our clients include:
- The size of their nest egg, obviously bigger is better here but there is no one right number.
- Their spending level. This of course is critical.
- Their relative health. While this can and often does change as we age, a person’s general health can be an indicator of what’s to come. Also their family history can be a factor.
- Longevity. Again we don’t know what the future holds, but a family history of longevity or the lack of it can be an indicator.
- Other assets and resources the client may have.
Since self-insuring isn’t for everyone, continue reading to learn five creative ways to fund long-term care costs.
At What Age Should You Get Long-Term Care Insurance?
The optimal age to purchase long-term care insurance is a balancing act. Coverage is cheaper when you’re younger and insurers prefer to issue policies to healthy individuals. However, you don’t want to pay annual premiums during a time when insurance isn’t critical.
As a rule of thumb, many financial advisors look at the age range of 60 to 65 as the optimal window to consider purchasing a policy. You will want to look at your unique situation in making this determination.
Alternatives to Buying Traditional Long-Term Care Insurance
Aside from buying a long-term care insurance policy, there are a number of creative ways to fund potential long-term care costs.
These can be used as a stand-alone or in combination with other funding methods.
Here is a look at some of these alternative solutions.
Leveraging Home Equity
If you’ve paid off your home or have a high level of home equity, you might consider tapping into that asset to fund long-term care costs.
Reverse mortgages have gained popularity for seniors as a way to access the equity they’ve built up in their homes without having to sell it or refinance it. Reverse mortgages are subject to a number of federal regulations. Essentially reverse mortgages allow you to convert a portion of this equity into cash for needs such as funding long-term care or general cash flow needs in retirement.
You must be at least age 62 to get a reverse mortgage. Terms vary, but typically the loan doesn’t need to be repaid. You and your spouse can generally continue to live in the home for as long as you’d like or until death. The mortgage is typically paid off when the home is sold.
These vehicles are quite complex and there are a number of federal rules and regulations. There are also several types of reverse mortgage options available. One issue to understand is that going this route likely means that you will not be able to pass your home to your children or other heirs as part of your estate planning.
Home equity lines of credit or HELOCs can be a low cost way to borrow against the equity in your home. A HELOC represents a line of credit against the equity in your home. The advantage here is that rates are generally low.
It’s important to understand, however, that this is a loan with repayment terms. It’s also important to know that the interest on a HELOC is no longer tax-deductible even for those who can itemize deductions under the tax reform passed in 2017. The only exception is to fund home improvements.
Roth IRA Conversions
Roth IRA conversions can be a tax smart way to fund long-term care expenses. A Roth IRA is not subject to required minimum distributions and can be allowed to grow tax-free until such time as the funds might be needed to cover long-term care expenses.
The beauty of a Roth IRA as a savings mechanism for long-term care expenses is that the money can be invested and grow tax-free until needed. As long as you are at least age 59 ½ and it’s been at least five years since the initial contribution or conversion to a Roth IRA account, then the money can be withdrawn tax-free as needed to cover these costs.
The Roth IRA conversion entails converting a traditional IRA account to a Roth IRA account. There are a number of options here in terms of how and when to do this based on each person’s situation.
One option is to take a portion of the money in their traditional IRA each year and convert those funds to a Roth IRA. The key here is to try to convert an amount that will allow you stay within your current tax bracket in that tax year.
An example of how this might work would be a 55-year old with $500,000 in a traditional IRA account.
Depending upon their income for a given year, they might convert anywhere from $10,000 to $25,000 annually to a Roth IRA. If they did this over a 15-year period and the average annual conversion was $15,000, they would have converted $225,000 to a Roth IRA.
Add in any earnings within the account and they might have upwards of $300,000 in the account that could be used to fund all – or a large portion of – their long-term care needs with tax-free withdrawals.
Another option for those who earn too much to contribute to a Roth IRA is to do a backdoor Roth conversion. This entails making an after-tax contribution to a traditional IRA account and then doing the conversion to a Roth IRA.
The amount taxed will be calculated proportionately to any other traditional IRA funds you have that were either contributed on a pre-tax basis or that represent earnings on your contributions.
Health Savings Accounts (HSAs)
An HSA is a medical savings account that can be utilized with a high-deductible health insurance plan. Many people may have access to them as an employee benefit through their employer. Others can access them in conjunction with high deductible plans purchased privately.
An HSA allows pre-tax contributions to the account which can be withdrawn tax-free to pay for qualified medical and related expenses. The power of HSAs as a savings vehicle to cover long-term care costs is that money contributed can be carried over from year-to-year if it is not used in the year it is contributed. Many HSA accounts offer investment options allowing you to invest contributions over a number of years.
In terms of long-term care costs, both the payment of premiums for long-term care insurance and the payment of expenses related to long-term care can be qualified expenses.
- Certain long-term care insurance policies are designated as qualified contracts and the premiums are therefore qualified expenses. Note there are limits on how much can be withdrawn as a qualified expense to cover premium payments, these amounts increase as you age. Still any payments that can be made with tax-free dollars provide at least some cost savings.
- The HSA can also be used to accumulate a fund to cover long-term care expenses down the road. The money can be withdrawn tax-free to cover qualified long-term care expenses. The benefits here is that you are able to pre-pay some of these future costs while working and with pre-tax dollars.
The 2023 contribution limits are $3,850 for an individual and $7,750 for a family. For those who are 55 or older an extra $1,000 catch-up contribution is available as well.
The savings potential is powerful. For a married couple who contributes the maximum each year starting at age 50, they could conceivably accumulate $150,000 or more by age 65 to put towards long-term care expenses in retirement. This amount could grow further over time through investments until needed. Note that HSA contributions cannot be made once a person commences Medicare coverage. If the HSA funds are not needed for long-term care expenses, they can be used to pay other qualified medical expenses including Medicare premiums.
A Life Insurance-LTC Combination
Another option for long-term care coverage is a life insurance policy with a long-term care rider. A rider is an add-on to the policy that provides the ability to receive a portion of the death benefit while the insured is still alive. Policies differ a bit from insurer to insurer, but in general the accelerated death benefit can be triggered by a diagnosis of a chronic condition that prevents the insured from taking care of themselves.
Buying this type of policy has several advantages:
- The premium on the life insurance policy, which is a permanent life policy, is fixed. Unlike premiums on a regular long-term care policy, the premiums on this policy cannot increase.
- Most of these combo policies will guarantee a return of your premium as well if you need long-term care.
A potential disadvantage of this type of policy is that by using some or all of the death benefit to pay for long-term care costs, that portion of the death benefit is not available for your intended heirs.
Speak with the Right Financial Advisor For You
It’s important to find a financial advisor who understands the need to plan for long-term care expenses. It’s also important they can present lower-cost solutions and don’t jump to sell you long-term care insurance.
There is no single right answer in funding potential LTC expenses.
To learn more about how you can optimize your long-term care and retirement planning needs, click here to learn more about our Sleep on It Process.
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