Long-Term-Care Annuities Offer Retirement Income, Tax Advantages

By Richard A. McGrath, CIC, LIA

Now you can save for retirement and protect yourself from the burden of long-term care costs both at the same time.

The new LTC annuity not only provides ongoing retirement income and coverage for long-term care, beginning this year it also has significant tax advantages.

Even those who have had the discipline to save regularly and invest for retirement are subject to the risk that their savings will be wiped out if long-term care is needed.  Long-term care is not covered by health insurance, Medicare or other government programs and costs an average of $72,270 a year for a semi-private room, according to national statistics from the 2009 MetLife’s Mature Market Institute.  In Massachusetts, the cost is even higher — $293 a day or $106,945 a year.

The National Clearinghouse for Long-Term Care Information estimates that 70% of people over age 65 today will need long-term care services.  If baby boomers live longer that today’s seniors, the percentage needing long-term care may be even higher.

LTC insurance has been available for many years, but it is relatively expensive and most consumers are understandably reluctant to spend a lot of money on something they may never need.

LTC annuities are a better option for many, because they provide an annuity payout, so the insured realizes a benefit, whether or not long-term care is ever needed.  An annuity is a long-term contract between the buyer and an insurance company, in which the buyer agrees to contribute a lump sum or series of payments in return for regular payments for life.  There is generally no limit on the amount of money that can be invested in an annuity.

In addition to providing lifetime income, annuities provide tax-deferred earnings.  Like earnings on 401(k) plans or IRAs, earnings are not taxed until they are distributed as income.  However, unlike 401(k) plans or traditional IRAs, contributions are made using money on which income taxes have already been paid.  Like distributions from 401(k) plans and traditional IRAs, distributions from annuities are taxed as ordinary income.

Given that the average life span is increasing and those who are preparing for retirement have to worry about outliving their retirement savings, an annuity is a sensible addition to most retirement portfolios.

In the past, when retirement typically lasted five years or so and company defined-benefit pensions provided ongoing income for life, annuities were unnecessary.  Today, defined-benefit pensions are rare and retirement often lasts 20 years or more.  An annuity can be a smart way to supplement other retirement investments, such as a 401(k) plan, because it can provide income for life, no matter how long you live.

There are many types of annuities, but the two major types are fixed and variable annuities.  Fixed annuities pay a fixed amount for life, so over time the income they produce will not keep up with inflation.  Variable annuities provide income that varies over time, based on the performance of the underlying investments.  Your annuity investments will produce more income over time if the underlying investments perform well, but they will produce less income if the underlying investments perform poorly.

A joint and survivor annuity is a popular option for retirees, because it continues to provide income to a survivor after the death of the owner, usually at a rate of 50 percent, 75 percent or even 100 percent of the original level.  Some annuities can even provide an inheritance for heirs.  A refund life annuity, for example, provides the beneficiary with a lump-sum payment benefit based on the current dollar value of any unpaid units.

Fees should also be considered when purchasing an annuity.  In addition to annual fees that are based on a percentage of assets, annuities often carry surrender charges.  Surrender charges begin at a set percentage and decrease each year over six to eight years.

There are also many types of LTC insurance.  For example, some policies cover only care in a nursing home, some cover only home health care and some cover both.  Ideally your policy should cover skilled, intermediate and custodial care in your home, an assisted-living facility and a nursing home.  Your policy should not exclude coverage for dementia, which is a very common reason for needing nursing home care, and it should provide increases in coverage adjusting for inflation.

Be sure that the insurance carrier issuing your LTC annuity is financially stable and well regarded.  Guarantees, such as lifetime income, are based on the ability of the insurer to pay claims.

Tax Advantages

LTC annuities are growing in popularity now, not only because of the growing need for them, but because changes in the federal tax code make them especially attractive.  Because of a change effective Jan. 1, 2010, LTC insurance premiums can be paid with pretax dollars, using the income stream from your LTC annuity.

The new law also allows a 1035 exchange.  If you already have an annuity, but it is not an LTC annuity, the new law allows you to exchange your old annuity for an LTC annuity.

LTC annuities can be a great bargain if you live a long time and end up needing nursing home care or home health care.  If you end up dying early, you will collect little or anything from your LTC annuity.  Your premiums will be invested by your insurance company and the returns on their investments will fund someone else’s retirement.

Still, that’s a risk worth taking for most people.  In fact, an LTC annuity can protect your other savings by helping to ensure that you don’t outlive your savings and don’t have to use it to pay for long-term care.

LTC annuities are still a new product and are not yet being widely offered.  Given the wide range of features and fees they may include, it is best to work with your independent insurance agent to ensure that you’re purchasing the policy that’s best for you.

Richard A. McGrath, CIC, LIA is President and CEO of McGrath Insurance Group, Inc. of Sturbridge, Mass.  He can be reached at rmcgrath@mcgrathinsurance.com.

This article is written for informational purposes only and should not be construed as providing legal advice.