Financial Articles by Experts

The federal Pension Protection Act of 2006 went beyond retirement plans. New breaks were added that make long-term-care (LTC) insurance more attractive for many people.

What changed: The new law permits LTC riders on annuity contracts. Formerly, these riders were allowed for life insurance policies but not annuities.

Why this matters: Policies providing only LTC insurance are “use it or lose it” vehicles. If you don’t end up ever needing long-term care, the money spent on insurance is never recovered.

Attractive new alternative: You can buy a life insurance policy or an annuity with an LTC rider. If you need care someday, the contract’s investment value can be tapped. On the other hand, if you don’t need long-term care, at home or in a nursing home, the rider need not be used. You can collect cash flow (from an annuity) or provide for a beneficiary (via life insurance).

Example: Linda Jones buys a $500,000 life insurance policy with an LTC rider. If Linda needs to go into a nursing home, the policy will pay the costs.

Suppose the policy winds up paying $100,000 to the nursing home. At Linda’s death, the policy’s beneficiaries would collect $400,000 instead of $500,000.

Who should consider buying one: These combination products work best if you want life insurance or an annuity as well as LTC. (An “annuity,” in this context, generally refers to a deferred annuity, in which the investment account can grow on a tax-deferred basis.) Otherwise, you’re paying for benefits you don’t desire.

However, if you do want insurance or an annuity, adding an LTC rider might be a cost-effective way to protect you and your family from the possibly painful expense of long-term care.

NEW TAX BREAK FOR LTC INSURANCE

The Pension Protection Act likely will spur increased availability of life insurance policies and annuities with LTC riders. Moreover, another provision of the Pension Protection Act will provide tax breaks for acquiring such LTC coverage.

How it will work: The contract’s cash value can be used to pay for the LTC rider. Under prior law, you would pick up taxable income from such a transaction. Now, this maneuver won’t be taxed.

Example: Bill Smith invests $50,000 in a deferred annuity. Over the years, his contract value grows to $55,000, $60,000, etc. Inside the annuity, earnings aren’t taxed. Bill can use those earnings to buy an LTC rider.

Bottom line: LTC insurance can be acquired with pretax dollars, within a life insurance policy or an annuity.

You can buy now: The law changes listed above will not take effect until 2010. However, you don’t have to wait until 2010 to buy a combination product.

Policies combining life insurance with LTC insurance have been on the market for years.

You can buy these products now, in anticipation of using the new tax breaks in the future.

If you wait: Even if you don’t want to buy such a policy now, you can make additional payments to a deferred annuity or permanent life insurance policy. Cash value will build up tax deferred. In 2010 or beyond, you can use that cash value to buy LTC coverage with untaxed dollars within the existing contract. You’ll also be able to exchange a life insurance policy or an annuity for an LTC policy.

SAVVY MOVES WITH STAND-ALONE COVERAGE

If you have no need for life insurance or an annuity, you’ll probably be better off buying a pure LTC policy. Then you won’t pay extra for life insurance or annuity benefits.

When to buy: The ideal age to buy LTC coverage is between 50 and 65.

Younger people usually should not consider LTC insurance. Before age 50, you probably are many years from needing care and would be better off putting the money into college funds and retirement plans.

After age 65, LTC premiums become much more expensive. The older you are when you buy a policy, the greater the chance you’ll be in poor health, which will boost your premiums.

Check the fine print: Before buying any LTC policy, read the contract carefully to avoid future problems. Be wary of coverage that pays only for home care or only for nursing home care.

Get broad coverage: Choose a policy that will pay if you need care in a nursing home, an assisted living facility or your own home. Moreover, the policy should pay 100% of its daily benefit no matter where care is given.

MONEYSAVER FOR MARRIED COUPLES

One way to trim the cost is for each spouse to choose an LTC policy that will pay benefits only for a limited benefit period, perhaps three years. The shorter the potential benefit period, the lower the costs will be.

But choosing a short benefit period increases the risk that benefits will run out while care is still needed. To reduce this risk, a married couple can use a shared-care rider, a relatively new feature.

How it works: Such a rider allows a spouse who needs longer care to tap the other spouse’s benefit period. If one spouse dies without using up all of his/her benefits, the remaining potential benefits are available to the surviving spouse. This is a cost-effective way to provide extended benefits to a married couple.

NOT TOO LITTLE, NOT TOO MUCH

Even with a shared-care rider, LTC policies can be expensive. One way to cut the cost is to buy less coverage.

Trap: Buying less coverage will save you money but can leave you underinsured. You need to match your benefit with the area where you might need care.

Example: In the Raleigh/Durham, North Carolina, area, the average cost of a private room in a nursing home is $175 a day, according to a 2006 survey by MetLife. If you buy an LTC policy that pays $125 or $150 a day, most of the cost will be covered.

In San Francisco, though, the average cost is $311 a day. With a policy paying $125 or $150 a day, you’ll have much more to make up out of your own pocket.

In a high-cost area, paying more for a higher daily benefit might be prudent. See how your area stacks up by visiting the MetLife Mature Market Institute at www.metlife.com and clicking on “Retirement Toolbox” under “Retirement,” then choose “Long-Term Care Cost Calculator” under “Calculators.”

Bottom Line/Retirement interviewed Edward D. Fulbright, CPA/PFS, CEO of Fulbright Financial Consulting, PA, 5302 NC Hwy. 55, Durham, North Carolina 27713. His weekly radio show, Mastering Your Money, is available on-line at www.wncu.org/edf@moneyful.com.
(Article originally published March 2007)