The Combo Annuity/LTC Driver
January 28, 2010 by Cary Lakenbach
Americans have just survived a devastating period of asset depletion and shrinkage. For many retirees and near-retirees, the ability to pay for the costs of long term care and other retirement costs has been severely compromised.
What options are available for them? Are the costs affordable?
For many retirees and near-retirees, annuities have been the investments of choice when the decision to park investment dollars not needed for current expenses has been made. No taxes to pay now–that is a great feature. With variable insurance products, they can reallocate funds among attractive funds without a tax consequence. That is attractive too.
Those are just two of several factors accounting for the annuity’s popularity.
Yet, except for the very wealthy, investment dollars during the retirement years, including dollars inside of annuities, do need to be viewed as a source of funds when expenses are incurred, and especially when expenses increase significantly over what had been normal levels. Market researchers confirm that one of the major concerns people have is how to cover expenses if a family member, such as a spouse, needs to receive LTC services.
The insurance industry has largely focused its attempts to address such LTC needs via the stand-alone LTC policy; this generally attempts to cover all or most of the LTC costs an individual will incur.
Let’s be clear on what that means. It means that, in event of chronic illness, the insured will not have to pay any out-of-pocket expenses, except possibly to cover costs for an initial care period of typically 90 days. Said another way, the insured would only modestly need to cover LTC expenses with funds from sources other than the LTC policy.
There is much to like to like about stand-alone LTC policies. Since they in effect prepay one’s LTC costs through coverage paid for by premiums, the insured doesn’t have to draw on personal assets should care for chronic illness be needed.
This benefit comes at a significant premium cost, however. What does the target market of retirees and near retirees say about this kind of policy? They have clearly spoken over recent years with their wallets, so to speak. That is, sales of individual stand-alone LTC policies have plummeted over the past several years, according to sales figures from research organizations such as LIMRA, Windsor, Conn.
Given that assets for many have fallen greatly in the past two years, one finds it hard to imagine that such products will satisfactorily address the LTC need in the future.
Now 2010 has arrived, however. With it comes a change to federal tax law that allows extremely favorable treatment of so-called combination annuities. These annuities combine a LTC rider (that is tax-qualified under prescribed standards of federal law) with an annuity.
Under most of these designs, the insured’s annuity account value is paid out first, to be followed by a stream of LTC payments guaranteed by the insurer. Just as with stand-alone LTC designs, payments are subject to a maximum monthly amount and payable for similar benefit periods.
Under the combination annuity, the insured covers a material percentage, varying from 20% to 33%, of the LTC benefit via the annuity values. Under the new tax law, however, such payments are exempt from income tax.
In other words, the combination annuity provides a mechanism for the accumulated earnings of an annuity to be paid out income tax free. That of course is not otherwise possible with an annuity.
A significant cost reduction results from this design, somewhere on the order of 70% compared to stand-alone products. For example, at age 65, for a comparable set of benefits provided by a typical insurance company, a stand-alone LTC policy might cost $2,500 a year while the combination annuity’s LTC coverage would probably cost $700 a year.
Furthermore, should the insured die without becoming chronically ill, the heirs will receive the valuable and sizable annuity contract’s proceeds. Contrast this to the standalone policy where, if the insured dies, no benefits are payable. The stand-alone LTC creates a use-it-or-lose-it situation. If there’s no claim, there’s no payment.
The combination annuity thus provides an eminently affordable tax-favored solution to covering costly later-in-life LTC costs. Consequently, it can provide major demand-driven sales to an insurer’s and advisor’s annuity portfolio.
Cary Lakenbach, FSA, MAAA, CLU, is president of Actuarial Strategies, Inc., Bloomfield, Conn. His e-mail address is email@example.com.