Growing old is no fun. Most of us are currently in denial, but there likely will come a time when we can no longer care for ourselves. Thanks to early diagnosis and treatment, the days of conveniently dropping dead of a heart attack are becoming a memory. Likewise, fewer and fewer of us are having kids, so there will be few family members to lend a hand.

The statistics are scary. (Especially for women.) According to a report from the US Department of Health & Human Services:

• Over half of Americans turning 65 (in 2015) will develop a disability serious enough to require long-term services and supports (LTSS)
• Fortunately, most of us will only require assistance for less than two years (2.5 years for women)
• About 14% of adults will require assistance for greater than five years (18% of women)
• The average cost will be $138,000, which may come from a variety of sources, public and private ($182,000 for women)
• One in six adults will spend at least $100,000 out of pocket
• In 2018 the average monthly cost of a nursing home was $7441 for a semi-private room and $8365 for a private room. An assisted living facility is more reasonable at $3628 per month.

Sorry, Medicare won’t cover most long-term care expenses

Medicare covers “medical care” only. Medicare does not cover “custodial care”. Medical care is administered by a healthcare professional.

If you are recovering from surgery in a skilled nursing facility that is covered by Medicare. And your coverage is limited:

• Day 1-20: $0, completely covered
• Day 21-100: you owe $170.50 coinsurance per day
• Day 101 and beyond: you are responsible for all costs

In contrast “custodial care” does not require a healthcare professional. Custodial care includes help for activities of daily living (ADLs): toileting, dressing, bathing, self-feeding, ability to get in and out of bed, etc.

If you are suffering from dementia or Alzheimer’s you may require adult supervision, which is also considered custodial care.

Even if you can still manage ADLs, there may be other reasons you can’t stay in your home on your own. Can you still shop for, and prepare your meals? Do you remember to take your medication? Can you still manage a phone and dial for help when you need it?

Image by Steve Buissinne from Pixabay 

When should you buy long-term care insurance?

So, what are we all to do? The first option is to shop around for long-term care insurance (LTCI). This insurance will cover nursing home care, assisted living, adult daycare, and help if you can still stay in your home.

Like life insurance, the earlier you purchase it, the lower the premiums. Likewise, you need to buy insurance when you’re still healthy and can qualify. However, it’s difficult to pay for something you probably won’t need for several decades.

The American Association for Long-term Care Insurance recommends purchasing LTCI in your mid-50’s. They argue that any older and you start to develop medical conditions that will either disqualify you or result in a higher premium.

Indeed, rates may jump 6-8% for every year you delay after age 60. If you wait until age 65 you may be paying double what you would have paid at age 55.

The good news is that LTCI is guaranteed renewable. They can’t dump you.

However, premiums are not “locked in”. You will get hit with premium increases over time.

Also, most policies may have an elimination period, like a deductible. For example, your policy may not cover the first thirty or ninety days of care. So, if you’re in an out of a facility in that time, the cost will be completely out of pocket for you.

Likewise, there may be limits on the length of time you receive benefits. Three years? Five years? After that, you may be on your own.

Note, the longer the elimination period, and the shorter the benefit period, the lower the premium.

• If you do buy a policy don’t forget about inflation. Either purchase a policy with an insurance rider or purchase 2-4X more coverage than you think you’ll need

Keep in mind that costs for long-term care are rising at a faster rate than inflation: in 2018 costs to stay in an assisted living facility went up 6.7% in one year.

If you can’t afford to continue paying premiums, and you have nonforfeiture benefits on the policy (some states require it), then you may not completely lose coverage. You may either receive a refund of a portion of your paid premiums or reduced coverage based on what you’ve paid so far. Likewise, you can reduce your benefit and pay a lower premium if the new premium is too expensive.

All insurance products are regulated at the state level. Check if your state has a partnership program that establishes quality standards for LTCI. These programs are designed to encourage you to have viable options so that you don’t end up on Medicaid.

• In California where I live, the California Partnership for Long-term Care is a consumer resource and set of standards for LTCI, including 5% annual inflation protection, and asset protection should you need Medi-Cal

Long-term health insurance is not perfect. Fortunately, there are some alternatives.

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1. Worst case scenario—qualify for Medicaid

If you can’t afford long-term care insurance, you simply deplete your life savings down to around $2000 or so. Once you’re poor you can qualify for Medicaid. Medicaid most likely won’t pay for assisted living, but it will pay for nursing home care. Likewise, it will cover Medicare premiums.

To qualify you must earn a limited income and have limited saved assets. These limits vary by state.

• In California, for “Medi-Cal” nursing home care there is no income limit. However, your income—minus a personal needs allowance and a spousal allowance—will go towards your cost of care.
• Otherwise, income limits are around $1300 – $1800 per month.
• To qualify for Medi-Cal, your total assets must be no more than $2000 for singles, $3000 for couples
• California also has additional programs to encourage you to stay in your home longer

Most states have a “medically needy” definition with limits that kick in once income is “spent down” to pay for ongoing medical expenses. In other words, if your income is relatively high, but so are your medical expenses, you may still be eligible for Medicaid. Medicaid will then pay the additional expenses above the spend-down limit.

Note, that you can still own your home, one car, a burial plot, and personal items. These are especially important if you have a spouse at home, or you believe your stay is temporary. Likewise, Medicaid income and asset limits in all states are higher if there is a spouse still at home.

If you purchase LTCI via a state partnership program, many are designed so that you don’t have to spend down your assets before qualifying for Medicaid.

But as you would expect, a “Medicaid-funded” facility is not going to be cushy. Obviously, this option is not ideal.

2. Health Savings Account

Yes, your HSA will also cover the cost of long-term care. However, to have a sizeable account you would need to utilize a high-deductible health plan (HDHP) for most of your life and invest your HSA relatively aggressively.

And be ridiculously healthy.

For 2020 the annual HSA contribution maximum is $3550 (single). Over forty years (age 25-65) at 3% interest (after inflation), you could, in theory, accumulate over 250K in today’s dollars.

Based on the numbers above, that may cover you.

However, it’s highly likely that you’ll need to start using your HSA for actual medical expenses prior to needing long-term care.

If you happen to have a sizeable HSA account, it may be better to simply use it to pay for long-term care insurance in the first place.

Otherwise, you’ll need a backup plan.

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3. Hybrid annuity with long-term care coverage

As part of your retirement plan, you may already intend to purchase an annuity to pay for your living expenses during retirement.

An annuity provides a guaranteed income stream that 1) pays a fixed amount, regardless of what is going on with the market, and 2) pays for life, regardless of how long you live.

Social Security plus a pension used to cover this, however, as you should be aware, Social Security will only cover a portion of your living expenses.

The rest used to be covered by your pension; a pension that is quickly becoming an endangered species.

Now the idea is to use an annuity to cover part of what the pension would’ve covered.

There are various strategies for using an annuity as part of your retirement plan, but the simplest is to use it—plus Social Security—to cover essential expenses. These include housing, taxes, food, transportation, and healthcare.

Keep the remainder of your savings in the market, allocated between stock and bond funds. (Note, the annuity counts as “bonds” for asset allocation purposes.)

When the market is good, you can freely withdraw from your invested savings for discretionary spending like travel, hobbies, entertainment, or that new bathroom renovation you’ve been planning.

When the market is bad, you simply dial down the spending and live off your guaranteed income from Social Security plus your annuity.

Because you know you’ll always have the minimum living expenses you can afford to be more aggressive with your invested savings.

Hybrid annuities

If you are planning to purchase an annuity, investigate hybrid policies that also cover long-term care. These policies will allow you coverage of 3X – 5X the amount of your initial investment for long-term care expenses.

• For example, if you purchase a 100K annuity you may have an extra 400K (500K total) for long-term care costs

Note that your own money is depleted first before long-term care benefits become available.

Also, if you deplete the extra coverage you’re done. With LTCI, you at least have the option of paying a higher premium in exchange for no lifetime cap.

Also, you are “paying” for this long-term coverage in the form of a lower return than a regular annuity. But unlike LTCI you don’t have to worry about your premium going up over time.

Unlike LTCI, your money isn’t gone. If you don’t need long-term care, you or your heirs still get the accumulated cash balance remaining. (The 100K plus whatever tiny interest it has made, minus fees.)

Depending on your income needs, you may wish to have two annuities. One to cover your living expenses, and a second deferred annuity to cover long-term care.

Unlike regular LTCI, you need a hefty upfront “payment” to purchase the annuity in the first place. Depending on your situation, this may not be practical.

Also, like most annuities, you may be locked in for a certain number of years (eg, ten years). If you change your mind, you’ll need to pay a surrender fee prior to the end of this period.

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Annuity taxes

Any annuity payment you may receive as income is partially taxed. If you funded your annuity with after-tax dollars, then a portion of each payment will reflect a return of this original principal and is not taxed (as you’ve already paid the taxes).

The other portion is the income your money has made over time, and it will be taxed as ordinary income.

However, any money received from a hybrid annuity and used for long-term care is not taxed. (Any additional money above the cost of care will be subject to taxes as above.)

4. Hybrid life insurance with long-term care coverage

If you have a whole life policy with a cash balance, this works like the annuity above. You may have long-term care coverage of 3-5X your cash balance—part, or all, of your death benefit. This kicks in once you deplete your cash balance.

As above, any money used to pay for long-term care expenses is not taxed.

If you don’t need long-term care, you can either cash-out your policy or leave it for your beneficiaries.

Obviously, your insurance costs will be higher than with a typical life insurance plan. And the death benefit will be reduced by any amount used for long-term care.

If you don’t currently have a whole life policy, you can purchase one called a single-premium life insurance (SPL). Like the annuity, you transfer a big chunk of your savings into a life insurance policy that will continue to grow and be available to your beneficiaries in case of your untimely death.

Keep in mind, the return on your “investment” in a life insurance policy is very low. That’s money that you could otherwise invest more aggressively.

1035 exchange

Perhaps you already have a life insurance policy? One you’ve paid into for years. Now that the kids are grown and you and your spouse have retired, the need for insurance on your life isn’t as critical.

Consider a 1035 exchange to a hybrid policy that supports long-term care coverage.

A 1035 exchange allows you to exchange one life insurance policy for a different new policy. Or one annuity contract for another. All without any tax consequences.

You can also exchange a life insurance policy for an annuity, but not vice versa.

(However, surrender fees may still apply if you’ve not held your policy for long enough.)

If you currently have a contract without long-term care coverage—either an annuity or life insurance—you may be able to exchange it for one that does.

Considering that LTCI requires that you are relatively healthy when you apply, a hybrid insurance policy may allow you to get coverage if you are in poorer health. Maybe.

5. Life insurance with accelerated death benefits

If you have a whole life policy with a cash balance, it may also have an accelerated death benefit provision. This benefit allows you to use part, or all, of your death benefit to pay for medical costs and long-term care if you are chronically or terminally ill.

These funds are not taxed if you meet the IRS definitions. A chronically ill individual is unable to perform at least two activities of daily living (ADLs). A terminally ill individual is expected to be around for less than 24 months.

Your policy can also be sold to a viatical settlement provider. Money received can then be used to pay for your long-term care (and is also free from taxes).

Again, you may use a 1035 exchange to purchase a new policy with the features that meet your needs. However, you may need to requalify based on your health status. So, it may be best to do this earlier, rather than later.

Good luck!

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Additional Reading

• Will Social Security Still Be There When We Need It? Most likely

• Is Yoga Covered by my Health Savings Account? What About Sunglasses?

• Need More Money to Retire? Consider a Reverse Mortgage. One option to generate a guaranteed income stream for your remaining years

First photo credit: Dominik Lange on Unsplash (Photographer’s wife and her grandma.)

This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Links are included for reference but should not be considered an implied endorsement of these organizations or their products. Please seek out a licensed professional for current advice specific to your situation.