Two of the most misunderstood financial products on the market are long-term care insurance and annuities. Though they’re both provided by insurance companies, they are worlds apart when it comes to features.
Jump ahead to these sections:
- What Is a Long-Term Care Annuity?
- What’s the Difference Between a Long-Term Care Annuity and Long-Term Care Insurance?
- Who Typically Purchases Long-Term Care Annuities?
- How Do Long-Term Care Annuities Work?
- The Pros and Cons of Long-Term Care Annuities
- How Do You Purchase a Long-Term Care Annuity?
It’s been heralded as a creative move by insurers to combine these two products into a single solution for having money grow and providing money for long-term care if it’s needed.
To help you decide if a long-term care annuity would be beneficial to you or your family, we’ll start by defining what a long-term care annuity is. We’ll then delve into how it differs from a traditional long-term care insurance policy, its pros and cons, and more.
What Is a Long-Term Care Annuity?
A long-term care annuity, also known as an annuity with a long-term care rider, is a hybrid insurance product designed to serve two purposes:
- Take a deposited sum of money and have it grow on a tax-deferred basis
- Provide money to pay for long-term care services the annuity owner (annuitant) receives
Maybe the first question we should answer is, “What is an annuity?”
An annuity is a contract between you and an insurance company stating that you will receive a series of payments made at frequent intervals in return for making a lump-sum investment. Annuities are often used to help the annuitant make mortgage payments, fund their child’s education, or act as a supplemental retirement vehicle.
A good second question is, “What is long-term care insurance?”
Long-term care insurance is an insurance product designed to help you pay for the costs of nursing home care, assisted living care, and home care. It covers care received which is generally not covered by Medicare or health insurance.
So, a working definition of a long-term care annuity could be: a long-term care annuity is a hybrid investment product / long-term care insurance policy that will pay the annuity owner payments from the annuity for long-term care treatment received.
What’s the Difference Between a Long-Term Care Annuity and Long-Term Care Insurance?
We’ve touched on some of the differences above (investment vs. insurance), but perhaps the most significant difference between the two is what happens if you don’t use them.
When you buy an annuity, you name a beneficiary, just like buying a life insurance policy. You select your beneficiary to receive any remaining balance in your annuity when you die.
For example, Rachel deposited $50,000 into an annuity and never received a payment from it. When Rachel died, the annuity had grown to a value of $62,000. Rachel’s husband, Ben, received the $62,000 balance when Rachel passed away because she had named him as the annuity’s beneficiary.
Unlike an annuity, when you buy a long-term care insurance policy, you don’t name a beneficiary. The reason – the policy builds no cash value to be distributed when you die. Instead, it expires worthless at the time of your death or after all benefits have been paid out.
As an example, let’s use Rachel again, this time as the buyer of the long-term care insurance policy. When Rachel purchased the annuity, she also bought a long-term care insurance policy. During the five years before she died, Rachel had paid $12,000 in premiums to the insurance company, and she never submitted a claim or received a dollar in benefits.
What happens to the $12,000? Since the long-term care policy doesn’t have a named beneficiary, the insurance company keeps all of the premiums paid; Ben would not receive any money back from the insurance company.
Who Typically Purchases Long-Term Care Annuities?
People who buy long-term care annuities have two characteristics in common:
- They are comfortable with annuities as an investment product
- They believe they’ll probably need long-term care later in life
Not all people are comfortable with annuities. Some cite their belief that the interest rates paid by insurance companies on annuities pale in comparison to other types of investments, like stocks, bonds, or mutual funds.
Other people are not fans of insurance companies. Many have had poor experiences with claims payment or increasing premiums and resent paying thousands of dollars in premiums without seeing the benefits they expected.
Buyers of long-term care annuities are believers in the product, and insurance products in general. They’ve seen the statistics concerning the probability that they’ll someday need to receive long-term care, such as those cited by the Department of Health and Human Services (HHS), that indicate more than three out of four people will need long-term care at some point in their lives.
How Do Long-Term Care Annuities Work?
As mentioned, a long-term care annuity is a hybrid financial product that combines an annuity with a long-term care insurance policy.
The purchase of a long-term care annuity begins with a lump-sum deposit into the annuity portion of the contract. The type of annuity used is usually a “fixed annuity,” meaning the interest rate applied to the money in the annuity is set by the insurance company that sold the annuity. However, sometimes a “variable annuity” is preferred by some buyers who would like the annuities value to grow depending upon the performance of underlying investments, like mutual funds.
Once the annuity is funded, the long-term care insurance coverage is selected. The policy owner will choose:
- The number of years the benefit will be paid
- The daily benefit amount
- The elimination period before benefit payment begins
There will be a maximum lifetime benefit for the long-term care rider. This amount is determined by a formula used by the insurance company and can provide benefit maximums of 2x or 3x the lump sum deposit amount.
To activate the rider and begin receiving payment from the annuity, the insurer requires that you meet specific standards that necessitate your need for long-term care.
Those standards can be a diagnose chronic cognitive illness, such as dementia or Alzheimer’s disease, or the inability to perform at least two of the “activities of daily living,” which include:
The cost of the annuity depends in large part on the age and health of the annuitant. For example, someone in their forties or fifties and is in good health will pay a smaller premium for the same long-term care benefits as someone in their sixties or seventies and who has pre-existing medical conditions.
The Pros and Cons of Long-Term Care Annuities
According to the American Association for Long-Term Care Insurance, the popularity of hybrid life insurance and annuities combined with a long-term care insurance policy is now over 500,000 policies, compared with just under 400,000 in 2019. It’s evident that an increasing number of people see the product's value, particularly Baby Boomers.
Let’s look at the pros and cons of long-term care annuities.
Hybrid contracts are a good choice for someone with an existing health issue. You’ll find it much easier to get approved for a long-term care annuity than you will for a stand-alone long-term care insurance policy. For example, someone who has had balance problems and a hip replacement is unlikely to be issued a long-term care policy but would quite likely qualify for a long-term care annuity – depending on the insurance company's underwriting rules.
Long-term care annuities are also often more budget-friendly than an individual long-term care policy. With a long-term care rider, age and health do affect the cost, but you may pay less in premiums to get covered.
Another pro of the long-term care annuity is that it doesn’t have any rate increases like traditional long-term care insurance policies. Traditional policies have regular rate increases, which are determined by the insurance company, primarily by the number of claims they’ve paid out in relation to the amount of premiums they’ve collected. More claims than expected result in rising premiums.
One of the negatives of a long-term care annuity is the large upfront premium payment that is required. The challenge of this requirement is compounded by the fact that the older you are and the less healthy you are, the bigger that upfront premium becomes. Some buyers will sell off investments or raid their retirement account to purchase a long-term care annuity.
Upfront premiums aren’t required with a stand-alone long-term care insurance policy; you can pay your premiums monthly or annually. The only drawback of this advantage is that if you are late paying your premium, your policy may lapse without any value, and all of the premiums you paid would have been of no benefit to you.
Another drawback to long-term care annuities is taxation. When you receive a payment from the insurance company, the portion that is a return of your initial premium payment isn’t taxed, but the amount that is earned interest or investment gain is taxable. Stand-alone long-term care policy benefits generally wouldn’t be taxable.
How Do You Purchase a Long-Term Care Annuity?
Because annuities are insurance products, they must be bought through individuals with a valid license to sell insurance. This could be an insurance agent, or it could be a financial advisor, financial planner, or a Certified Public Accountant who also has an insurance license. They should also be experienced with pre-planning for long-term care.
The application process is very straightforward. First, you complete the application, and it is submitted with your premium payment. The insurance company then reviews your application, which includes questions about your health history, and they decide whether or not to approve the application. If they approve the application, they then determine what the premium will be based on your age and the condition of your health.
Like any insurance product, you’ll have a free-look period when you receive the contract back, during which you can return it for a full refund of the premium you paid when you applied. The length of the free-look period will vary by state but is generally anywhere from 10 days to 30 days.
Read Carefully Before You Sign On the Dotted Line
You should read any insurance policy or contract carefully before signing an application, especially one for a long-term care annuity. Since it contains two components, long-term care insurance and the annuity, it’s advisable to have a financial planner familiar with both of these products review the contract with you before you accept it. They can help you evaluate all of your long-term care options.