Relying on Family
In the past, when a person developed a loss in functioning, he or she was usually cared for by a family member. And course, this is still common today -- many people provide care to a spouse, an elderly parent, or another relative. But changes in society and in family structure are making this a less feasible solution for many people. Life expectancies are longer and families are smaller than in the past, so there are simply more elderly people needing care in proportion to the number of younger people available to provide it. There are also more single people and childless couples, so many people have no adult children to rely on. And while in the past many women did not work outside the home and were able to provide care, this is much less common today. Consequently, today when a person needs long-term care, there may be no family member to provide it. Or there may be one person who must take on the entire burden herself, or a married couple must try to raise their children, care for an elderly relative, and hold down full-time jobs all at the same time.
Clearly then, many people need to receive long-term care services from paid personnel. Can they simply pay for these services out of their own income and assets? Because of the cost and the anticipated impact of inflation, this is difficult if not impossible for all but the wealthy.
Amber is 45 years old. She is concerned about her long-term care needs and has been told that if she entered a nursing home in her area today and remained there for two-and-a-half years (the average nursing home stay), it would cost her $150,000. But she does not expect to enter a nursing home anytime soon -- she wants to plan for her needs 30 years from now. Based on the recent past, her financial planner assumes an average annual increase in long-term care costs of 5 percent. At this rate, costs double about every 15 years, so the cost of two-and-a-half years in a nursing home in Amber's area 30 years from now will likely be about $600, 000. And this does not cover the home health care services or assisted living that Amber may need for months or even years before she enters a nursing home.
Of course, Amber has 30 years to save and invest. But still, it will take an enormous effort. And at the same time she must pay for current living expenses and save and invest for her children's college education and her own retirement.
There are other problems associated with paying for long-term care out of one's own financial resources. Even if a person is able to pay for the care she needs, in doing so she may deplete family assets. What then becomes of her surviving spouse? He may see his standard of living lowered or even be forced into poverty. And how will he pay for his own long-term care?
The use of personal assets to pay for long-term care may also mean that inheritances are not left to children and grandchildren. This is particularly troubling when liquidated assets include a family business or farm.
Finally, what if long-term care is needed sooner than expected? To return to the example of Amber, what if she plans to accumulate in 30 years an amount sufficient to cover her needs, but after only 15 years she suffers a debilitating illness and requires care? She will not yet have the necessary funds.
Those who do not make plans to fund possible long-term care costs often end up having to pay for their care out of their own pockets because they have no alternative. Other people consciously plan to use their own income, savings, and assets to pay for care. Aside from savings accounts, stocks and bonds there are a few other funding sources self-funders can tap, including home equity, annuities, and life insurance policies.
The most important financial asset many older people have is home equity, the value of the home they own after any mortgage amount owed or other liability has been subtracted. The amount of home equity can be substantial, especially if the home was purchased many years before and the mortgage has been mostly or entirely paid off. In such cases, home equity can be an important source of funds to cover long-term care costs.
In the past, there were only two main ways of turning home equity into funds that could be used to pay for long-term care: selling the home or taking out a home equity loan. Each of these alternatives has serious drawbacks. Selling means leaving a longtime residence, and a home equity loan requires regular payments at a time when a person needs more income, not another expense. Fortunately, there is another method of drawing on home equity: reverse mortgages.
Reverse mortgages are typically available to those 62 and older. In a reverse mortgage, as in a conventional home equity loan, a bank lends money to a homeowner with the home serving as security. However, in a reverse mortgage, the homeowner does not have to make regular payments to the lender. Instead, the loan must be paid off only when the homeowner dies, sells the home, or moves out of the home.
Thus a reverse mortgage can be advantageous for an elderly person -- she can obtain funds from her home equity without having to worry about being able to make loan payments, as she would with a conventional home equity loan, and without having to leave her home.
The lender's payment to the homeowner can be made in a lump sum, in monthly payments, through a line of credit to be drawn on as needed, or a combination of these. The amount a lender advances a homeowner depends on several factors, including the value of the home, the homeowner's age, the interest rate charged, the type of reverse mortgage, the payout method chosen by the homeowner.
For most types of reverse mortgages, the homeowner can use the money received for any purpose, including long-term care. However, reverse mortgages do have some limitations and disadvantages as a long-term care funding source. If the borrower leaves her home permanently, the mortgage must be paid off, and if she remains in an assisted living residence or nursing home for 12 months or more, she is considered to have permanently left the home; consequently, while a reverse mortgage can fund home care and short stays in a facility, it is not a solution for extended nursing home care. Also, a person taking out a reverse mortgage will substantially reduce her home equity, leaving her with less to rely on as a financial reserve and to pass on to her heirs. Finally, given the high cost of long-term care, the funds obtained from a reverse mortgage may not be adequate to cover costs.
An annuity is a type of investment. The investor (called the annuitant) pays money to an insurance company and in return the insurer makes regular payments to the annuitant over a period of time. Depending on the type of annuity, this period may be for as long as the annuitant lives or for a limited, predetermined time. The amount of the payments made to the annuitant may be fixed and unchanging, or it may vary according to the performance of the investments the annuitant's money is placed in.
The payments from an annuity can be used to pay some of the cost of long-term care services. Alternatively, an annuity can be used in combination with long-term care insurance -- the annuity income pays for the premiums of an LTCI policy, and the policy covers the costs of care.
Unless a very large amount is invested in an annuity, the payments will cover only a portion of long-term care expenses. It should also be noted that annuities have costs and charges that can make them in some ways less attractive investment vehicles than mutual funds or individual stocks and bonds.
A life insurance policy provides protection against the financial consequences of the death of an individual. If a covered person (an insured) dies while the policy is in force, the insurer makes a payment (known as a death benefit) to the beneficiary(s) designated by the insured. People purchase life insurance for various reasons: to ensure the financial security of a spouse, children, and other family members; to preserve an estate for heirs by providing money to pay estate taxes and settle outstanding debts; or to create an inheritance for a loved one or a charity.
Life insurance was not developed to meet long-term care needs. But a person can obtain money from her life insurance policy in various ways and use that money to pay long-term care expenses. However, as we will see, this approach has serious disadvantages and should generally be used only as a last resort by those who have no other options.
Accelerated death benefits
Accelerated death benefits (also known as living benefits) are payments of a portion or all of the death benefit before the death of the insured. For an insurer to pay accelerated death benefits, an event specified in the policy (a benefit trigger) must occur. In early versions of these benefits, the insurer paid only if the insured suffered from a terminal illness, and that is still a common triggering event. However, many policies have more flexible benefit triggers: diagnosis of one of several specified critical illnesses; permanent confinement to a nursing home; the need for extended long-term care (in a facility, at home, or in the community) because of an inability to perform a specified number of ADLs; and/or a cognitive impairment.
The amount available from accelerated death benefits varies according to the policy. That amount may be a fixed dollar figure or a percentage of the death benefit (50-80% is typical) .
Of course, monies advanced under the accelerated death benefit will reduce the benefits eventually paid to beneficiaries – and perhaps defeat the initial purpose of the insurance policy. Another problem is that most life policies are for relatively small amounts and the accelerated benefit may not cover long-term costs for an extended period of time.
Viatical & Life Settlements
In a viatical settlement, a terminally or chronically-ill insured (referred to as the viator) sells his life insurance policy to a viatical company. The viatical company pays the viator a lump sum for somewhat less than the policy's death benefit. In exchange the viatical company becomes the owner and beneficiary of the viator's policy, pays the premiums and eventually receives the death benefit after the viator dies.
This transaction has advantages for both parties. The viator gets money while he is still alive, which he can use for any purpose. The viatical company usually earns a profit because the lump sum it pays the viator (plus premiums) is typically less than the death benefit it receives after the viator dies.
Many states today permit life settlements as well as viatical settlements. The two are similar in that both involve the sale of a life insurance policy to a third party. But for a life settlement there is no requirement that the insured be terminally or chronically ill (although he must be elderly -- generally only applicants over 70 are accepted). The lump sum amount received is much lower than for a viatical settlement because the life expectancy of the insured is usually much longer.
The money obtained from a viatical or life settlement can be used for any purpose, including paying for long-term care services or LTCI premiums. Proceeds from viatical settlements are typically received tax-free; there may be tax consequences for life settlements.
Like accelerated death benefits, a viatical or life settlement defeats the purpose of life insurance; when the insured dies no death benefit is available for taxes, mortgage payments, or survivors. However, for a person in need of long-term care services and without other means of paying for them, these settlements may be an appropriate funding source.
Policy Loans, Withdrawals and Surrenders
There are two types of life insurance. Term life insurance is in force for a limited, specified period (the term of the policy), and it pays a death benefit only if the insured dies during that period. Permanent life insurance, on the other hand, is designed to be in force for the entire lifetime of the insured. It generally remains in force until the insured's death unless he lets it lapse by failing to pay premiums.
While both term and permanent life insurance policies have death benefits, a permanent policy (but not a term policy) also accumulates a cash value. The cash value of a policy normally grows during the life of the policy as the insured pays premiums and those premiums yield investment earnings. An insured can access her cash value by means of a policy loan, a policy withdrawal, or policy surrender.
As with accessing the death benefit of a policy, accessing the cash value tends to defeat the purpose of life insurance by reducing or eliminating the benefit available to heirs, and the accumulated cash value is not usually sufficient to pay for long-term care for very long.