insurance

New: A hybrid annuity with LTC coverage

Lifesaver
Highlights
  • These policies require a large upfront fee rather than regular payments.
  • If not needed for long-term care, they are an estate planning tool.
  • Cons: Your money is locked up for a long time, and returns are meager.

One of the things that can discourage people from buying long-term-care insurance is the idea of paying a lot of money for a policy that with any luck they'll never have to use.

Of course, almost all insurance is like that. But long-term-care insurance is particularly expensive and frequently, its purchase comes at a time when people are facing retirement and looking for ways to cut back.

Hybrid policies

One way to avoid spending a lot of money directly on a long-term-care policy while still getting its benefits is to buy an insurance policy with a long-term-care rider.

These hybrid policies work variously, but the type that has gotten the most attention is a long-term-care annuity. Beginning in 2010, the IRS will let those who hold one of these deferred annuities use the money to pay for long-term care free of federal taxes. Annuities allow money to grow tax-free, but the tax man has to be paid when the money is removed. These long-term-care annuities free holders from this obligation.

Several insurers, including Mutual of Omaha, Genworth, Bankers Life and OneAmerica, now offer hybrid deferred annuities.

Most hybrid deferred annuities operate this way:

Purchasers put money -- $50,000 is about the minimum -- into an annuity. These also can be funded with another annuity or a whole or universal life insurance policy that the owner no longer needs through what the IRS calls a 1035 exchange.

Purchasers then choose the amount of long-term care coverage they want, usually 200 percent or 300 percent of the face value of the annuity, and they decide if they want inflation coverage. They also have to decide how long they want the coverage to last, usually two to six years. Inflation coverage will affect the maximum duration of the plan.

Genworth uses this clear-cut example:

A 60-year-old purchases a $50,000 long-term care annuity with 5 percent inflation protection compounded annually with a 200 percent coverage maximum and a six-year benefit period. So, his initial long-term-care coverage maximum is $100,000 -- double the premium he paid. (If he had refused inflation protection, then he could have chosen three times the premium, or $150,000.)

If he makes no withdrawals over 20 years at a 3.5 percent compound interest rate, minus administrative fees, he would have -- under the 5 percent inflation-protected scenario --$265,330 available in long-term-care insurance. Or a monthly maximum of $3,685.

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If this person never needs long-term care, then the annuity can be redeemed for its accumulated value when it matures at 20 years -- or it can be left to accumulate further interest and the long-term care policy will remain enforce.

When this person dies, his heirs will inherit the greater of the accumulated annuity value, if there have been no withdrawals, or the single premium he paid initially less the amount of long-term care paid.

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