64% of retirees who file for bankruptcy do so because medical expenses have wiped out their savings. (1)
Before retirement, market volatility and inflation are top of mind risks to manage. During retirement, in addition to managing these risks come the risks of:
- living too long,
- annually increasing healthcare costs depleting savings, and
- leaving inadequate income for a surviving spouse.
Healthcare costs are a big-ticket item for most retirees. With healthcare inflation at double the regular rate of inflation — or roughly 2.5% — out of pocket healthcare costs in retirement are estimated to be in the range of $265,000 to $349,000 for a married couple age 65 today.1
Consider that a person age 65 today has a 70% chance of needing some type of long-term care during retirement. 2
Also consider that long-term care is a progression of care options across life stages, ranging from informal assistance to more professional care at an assisted living facility.
Notably, more than half of long-term care services are being provided inside the home, currently.3
It is estimated that one year of home health care — which averages roughly $44,000 per year today — will cost approximately $96,000 by year 2032 (assuming a 4% rate of inflation, 40 hours/week).5
Going “Long” on Longevity
Fortunately, 75% of affluent baby boomers who have discussed retirement with their financial advisor say that they plan to also discuss how to mitigate these potential healthcare costs.4 Financial advisors can then help their clients:
- manage the potential risks to their portfolios from long-term care expenses;
- assess the various options available to cover the unpredictable expenses associated with long-term care, in the home or outside;
- help clients be realistic about what features and limits the various options offer, and;
- help clients preserve the returns on the portfolios they manage, especially in times of market downturns.
3 Risk Management Solutions
There are generally 3 types of insurance policies that help mitigate the risk to retirement assets from health care expenses associated with a chronic illness or long-term care, and allow clients to ‘go long on longevity’:
- Traditional LTC Insurance Policy (LTCi). Stand-alone Long-Term Care insurance policies are the traditional insurance policies familiar to many. Premiums on an LTCi policy must be paid annually. However, with most of these policies premiums are waived when benefits begin. An insured age 55 may be paying premiums for many years before taking any benefits, if any. Because women live longer than men, all other things being equal, premiums are generally higher for women on these policies.
- Life Hybrid Policy. Clients who feel queasy about purchasing an LTCi policy they may never use, may consider a life insurance hybrid policy with an LTC rider or a chronic illness rider. Hybrid policies allow the death benefit to be accelerated during lifetime to cover long-term care costs, if and when needed. This way, if the rider is never exercised the heirs will receive the death benefit as a tax-free inheritance. However, there are no inflation adjustments available with hybrid products, like there are for traditional LTC policies or Linked Benefits, as discussed below. Note that with hybrid products, any death benefit available to heirs will be reduced by the amount of the LTC benefit used.
- Linked Benefits Policy. A Linked Benefit policy, also referred to as an asset-based policy, allows the policyowner to contribute a one-time lump-sum into the policy and receive coverage for long-term care expenses if and when needed in the future. There is also a small death benefit for beneficiaries on these policies, assuming the full LTC benefit is not used. Several Linked Benefit policies provide a return of a portion of the premium paid if the policy is surrendered. Note that several insurers who offer Linked Benefit policies now allow insureds to make annual payments into the policy instead of a lump-sum. Annual payment options are often of short duration such as 1, 3, 5 or 10 years—but can sometimes be longer.
Take a look at the following hypothetical comparison of the 3 Risk Management Solutions.
The Risk Management Solution: 2 Types of Contracts for Covering Long Term Care Expenses
Cash Indemnity Contract. Under a Cash Indemnity contract, the insurer sends payments directly to the policyowner each month without requiring receipts. Excess funds not needed can be used for home safety improvements, prescription meds, massage therapy or home maintenance, for example. Licensed caregivers are also not required to provide the care under a cash indemnity contract, which allows family and neighbors who provide care to be paid.
Reimbursement Contract. The policy owner or caregiver submits receipts to the insurance carrier for approval. Once approved, the carrier reimburses the amounts on a monthly basis up to the amount for which he or she qualifies. Generally, carriers do not reimburse for care provided by family members or close friends under a hybrid product with a reimbursement contract.
The Risk Management Solution: Tax Incentives
Note that a Health Savings Account (HSA) can be used to fund premiums on qualified contracts that cover long-term care costs. This means that the premiums, up to a limit, can be paid using the HSA funds.
An HSA is available to taxpayers who have a high deductible health plan (HDHP), who cannot be claimed as a dependent, and who are not enrolled in Medicare9. The HSA can be sponsored by an employer or the client can opt to open one independently. The maximum a client can contribute, on a pre-tax basis to an HSA in 2018 is $3,450 for an individual account or $6,900 for a family. If the client is age 55 or older, an additional $1,000 can be contributed to either plan. Tax-free distributions can be taken from the HSA account any time for qualified medical or healthcare expenses, and the balance rolls over year to year. An individually directed HSA may be invested in a wide array of assets including stocks, bonds, and real estate. The investment earnings inside the HSA also avoid taxes. Note that a taxpayer does not need to itemize deductions in order to contribute on a pre-tax basis to the HSA.
If you have an HSA, you can withdraw money tax-free from it to pay a portion of eligible long-term care insurance premiums. The amount you can withdraw for premiums on a policy that qualifies is based on your age, as indicated in the chart below, which is subject to changes annually.
|Attained age before close of taxable year||2018 Limits|
|40 or less||$420|
Moreover, if a taxpayer has medical expenses that exceed 7.5% of their adjusted gross income (AGI) in any year, all or a portion of the premium paid on a qualified policy that covers long-term care costs can be itemized as a medical expense deduction on the federal tax return, subject to same age-based limits in chart above.
However, clients cannot double dip. That is, if HSA tax-free dollars are used to fund premiums for qualified long-term care coverage, up to the age-based limit in the chart above, then the premium cannot be deducted as a medical expense as well. Note that the 7.5% threshold will change to 10% of AGI with the 2019 tax return, as per the changes from the 2017 Tax Act. Individuals age 65 and older continue to benefit from the 7.5% threshold.
(1) Dr. Deborah Thorne, University of Idaho, Co-Principal Investigator, Consumer Bankruptcy Project, Post-doctoral Fellow & Project Director, Consumer Bankruptcy Project, Harvard University
1 Savings Medicare Beneficiaries need.” EBRI January 31, 2017.
2 Centers for Medicare and Medicare Services, Medicare & You 2016.”
3 American Association for Long Term Care Insurance Sourcebook 2015-2016.
4 “Healthcare and Long-Term Care Study,” a consumer study of U.S. adults ages 50+, Nationwide/Harris Poll Survey, November, 2016.
5 Market Survey of LTC costs, Mature Market Institute, November, 2012
6 Initial death benefit is $144,000 with $89,106 Return of Premium.
7Hypothetical IUL policy on Male age 55 and Female age 55, standard, non-smoker risk, illustrates as guaranteed to age 76 for Male, and age 77 for Female, assuming 0% return and maximum charges. Unlike a traditional LTCi policy, annual premiums are not waived while on LTC claim, and there is no inflation adjustment to the monthly LTC benefit on a hybrid product. If there is an existing loan on a hybrid policy when the insured claims LTC benefits, a portion of the accelerated death benefit will be deemed repayment of the loan and reduce the accelerated benefit otherwise payable. If the policy lapses, the LTC benefit will continue to be paid until the insured leaves the healthcare facility, the full accelerated death benefit amount is exhausted, or the insured dies. A policy lapse may trigger taxation.
8 Indemnity or Reimbursement contracts will determine whether receipts are required and who is defined as a reimbursable caregiver.
9 A High Deductible Health Plan (HDHP) is health insurance that has lower premiums but a higher deductible. An HDHP pays for catastrophic medical expenses and qualifies consumers to set aside tax-free funds in an HSA.HDHPs are an alternative to the plans offered by HMOs and PPOs that feature low deductibles but charge high premiums. In 2018 HDHPs must have a deductible of at least $1,350 for self-coverage and $2,700 for family coverage; maximums for deductible and out-of-pocket expenses are $6,550 for self-coverage and $13,300 for family and include money paid to satisfy the deductible, co-payments, and other expenses. These are all costs that the HSA may be used to cover.