Long Term Care Case Study #1

Barbara is a 75-year-old widow with a $300,000 non-IRA annuity that she bought years ago for $200,000. She lives very comfortably on social security and distributions from a $600,000 IRA. When asked about her purpose for the annuity she said, “That’s to pay for my long-term care expenses if I need it; but other than that, the money is for my kids and grandkids”. Unfortunately, Barbara is not aware of the extremely high taxation on distributions from annuities. Any gain above her “cost basis” of $200,000 will be taxed at ordinary income tax rates, not at the lower capital gains rate. So when Barbara passes away, based on the current value, her children are going to have to pay approximately $30,000 in federal and state income taxes, leaving $270,000.

Alternative Solution

Let’s look at an alternative solution for Barbara: Life insurance with a long-term care rider. Using the proceeds from the annuity to purchase life insurance with a single premium, the numbers become very attractive and the added benefits are compelling.

If Barbara surrenders the annuity she will incur taxes on the $100,000 gain in the policy, so she holds back $30,000 to pay the taxes when due. The remaining $270,000 is paid to a major life insurance company that offers a rider giving Barbara access to the entire death benefit for her long-term care needs. Assuming that Barbara is in reasonably good health for her age (not necessarily perfect health), the death benefit would be over $530,000. As opposed to annuities, life insurance proceeds pass income tax free to her estate! During her life, Barbara would have access to up to 2% per month of the death benefit, tax free, to pay for long-term care expense. Based on the $530,000 policy that would give her access to up to $10,600 per month for any expense incurred if she were to need help with 2 or more “activities of daily living”, or if she should be diagnosed with dementia. She can receive treatment either at home or in a formal facility, that decision is hers. Even if she were to use the maximum monthly benefit, the rider would cover these excess expenses for 50 months, that’s over 4 years.

Results

Using proceeds of the policy to pay for these expenses, the death benefit is only reduced on a dollar-for-dollar basis and the balance of the death benefit will go to her children tax free. If she doesn’t need the policy for long-term care expenses, her children will get $530,000 tax free.

By comparison, if Barbara were to keep the annuity, the value would have to grow to almost $700,000 for Barbara or her children to have the same proceeds available as the life policy would. Considering how conservative Barbara is, this is not likely to ever happen.