The government must be getting worried about all those aging baby boomers. With healthcare in jeopardy, it recently took a step to shift healthcare costs back to the taxpayer. A former change to the tax law allows long-term care (LTC) insurance premiums to be paid with pretax dollars. This seemingly innocuous move has created the "LTC annuity," a combination of LTC insurance and an annuity.
Tutorial: Introduction To Insurance
Fundamentally, the LTC annuity is simply a repackaging of two existing products, but with a slight spin. As the name suggests, an annuity is overlaid with LTC insurance, but the tax code allows premiums to be deducted from the annuity's income stream without creating a taxable event. This effectively lowers the cost of the LTC insurance premiums, thereby encouraging people to purchase these policies, alleviating future strain on social programs.
It is nearly impossible to offer a single analysis that can be applied across the board to all LTC annuities. Insurance products always differ slightly from one company to the next, and the tax code is constantly in a state of flux. What is possible is to examine the financial underpinnings of annuities and LTC insurance separately. This will assist in evaluating a combined LTC annuity product.
Annuities can take two forms. The first is that of a tax-deferred investment vehicle. The second is an insurance policy designed to protect income in retirement (a retirement annuity). It is the retirement annuity that is the basis for the LTC annuity. (To learn more about annuities, see An Overview Of Annuities.)
A retirement annuity is very simple to understand. With this product, an investor pays a portion (or all) of his or her retirement assets in exchange for a guaranteed stream of income for life (the spouse's lifespan can be insured as well). The advantage of a retirement annuity is straightforward. Many people fear they will outlive their savings or make unwise investment decisions. A retirement annuity completely eliminates these concerns because it is a form of income insurance, as opposed to an investment that entails risk. The catch, however, is that when you die, the insurance company keeps your money.
In order to provide guaranteed income, insurance companies pool large sums of money and execute sophisticated investment strategies well beyond the scope of what an ordinary investor can do. Moreover, because an insurance company is an ongoing business, it has a longer investment horizon than the average retiree. As a result, it can invest in riskier investments. When you combine these factors, insurance companies can realize a substantially higher rate of return than most individual retirees.
The best way to "win" with an annuity is to live a very long time and collect an income stream in excess of what you would have otherwise produced on your own. However, if you die shortly after purchasing an annuity, the insurance company wins, keeps your assets and your family loses out on an inheritance. All in all, retirement annuities are neither good nor bad. They depend completely on your individual situation. (For more on the pitfalls of annuities, check out Watch Your Back In The Annuity Game.)
The other half of an LTC annuity is LTC insurance. This form of insurance is designed to provide financial protection against the enormous costs of nursing homes and assisted living facilities. These policies offer solace for those who fear depleting their assets on healthcare. LTC insurance protects your family's potential inheritance, and can relieve fears of ending up on government aid and languishing in a substandard facility. These policies offer profound peace of mind and are generally a very good thing. (For more on the importance of LTC insurance, see Taking The Surprise Out Of Long-Term Care.)
Putting It All Together
From a financial standpoint, there is nothing revolutionary about LTC annuities. Moreover, there is no inherent benefit to combining LTC insurance and a retirement annuity as opposed to purchasing them separately. However, from a marketing standpoint, insurance companies may end up creating a very popular product.
If they become popular enough, there is the possibility for cost reductions, but at this point it this is just a possibility, not a reality. By pooling more and more people into LTC insurance policies, risk can be spread across a greater number of people, lowering the total cost at the individual level. On the other hand, the tax law could broadly increase demand for LTC insurance, and companies could seize upon this opportunity to increase premiums and profit margins. It is difficult to be certain how these changes could play out at the societal level.
Again, keep in mind that LTC annuities do not represent a new paradigm in insurance products. At the moment, they are just two existing products in a fancy package.
Is an LTC annuity right for you?
To determine whether this product is a good match for your retirement plans you should follow these steps:
- Sit down with your financial planner and objectively evaluate whether you even need a retirement annuity or LTC insurance. Those who have prudently saved and invested throughout a lifetime may find neither product is needed.
- Seek advice from a "fee-only" advisor not a commissioned advisor; otherwise, you will likely hear that more insurance is always the answer. Commissions on insurance products are incredibly high, and are well in excess of commissions on investment products. (For more insight, see Paying Your Advisor - Fees Or Commissions?.)
- If you decide to purchase an LTC annuity, get as many quotes as possible. Again, the insurance industry is extremely heterogeneous and costs will vary widely for what is essentially the same service.
- Once you have a series of quotes in hand, have your advisor run a cost-benefit analysis between the policy and what your investment portfolio could reasonably produce. It may turn out that you can self insure.
- Before you commit to a policy, check on the financial well-being of the insurance provider. Insurance contracts are not guaranteed by the U.S. government. A policy is only as good as the company that issues it.
The Bottom Line
Insurance is meant to protect against risks you can't afford to bear. If you can reasonably bear the risk of providing for your retirement income and healthcare needs, do so and save yourself the cost of insurance.
To learn about another LTC option, read A New Approach To Long-Term Care Insurance.