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How Do Long-Term Care Annuities Work?

A reader writes in, asking:

“I do not have long term care insurance, and likely will not be able to buy any in the future due to a pre-existing medical condition. An acquaintance recently recommended that I consider purchasing a long term care annuity. I’ve been reading about them, but they appear to be complicated products. And I have learned the hard way that it’s wise to be skeptical of complicated insurance products. Could you shed some light on how they work, and perhaps some thoughts on whether they’re worth buying?”

Long-term care annuities are deferred annuities, in the sense that they have an accumulation stage and a distribution stage.

Background for readers who aren’t familiar with those concepts: With a deferred annuity, during the “accumulation stage” you have an account that grows at either a fixed rate of return (if you have a fixed annuity) or a variable rate of return (if you have a variable annuity). Then, if you want to, you can shift to the “distribution stage” (this is known as “annuitizing” the annuity). When you do so, you give up the account, and in exchange you get a guaranteed stream of income (e.g., a stream of income that is guaranteed to last for your life).

With a long-term care annuity, you purchase a rider that provides a degree of long-term care protection during the accumulation stage. Because this protection disappears when you shift to the distribution stage (i.e., when you “annuitize” the annuity), the typical plan when purchasing a long-term care annuity is actually to never annuitize it at all (i.e., to stay in the accumulation stage indefinitely).

The long-term care annuities I have looked at are either fixed or fixed-indexed annuities, meaning they provide a guaranteed rate of return during the accumulation stage. For the annuities I’ve looked at, a 1% guaranteed rate of return (or somewhere in that ballpark) was typical.

And you have to pay a cost for the long-term care rider. The cost is usually in the ballpark of 1% per year for somebody age 65 (higher if you’re older, lower if you’re younger).

When you consider the ~1% fixed rate of return together with the ~1% annual cost for the rider, we’re talking about a product that has roughly zero expected growth.

How Does the Long-Term Care Protection Work?

Firstly, it’s important to know that the details vary from one policy to another. But the general way the long-term care rider works is that, if you deplete your account value by paying for long-term care over a specified period of time, you get access to some additional funds that you can spend on long-term care over another specified period of time.

For example, a policy may require that you spend down your account value over two years by paying for long-term care. And if you do so, then an additional sum of assets (which would be a specified amount, such as 2x your account value as of the date that you started needing long-term care) would be released to you to spend on long-term care over another period (e.g., four years).

So with such a policy, you would get no benefit from the rider at all if you need less than two years of long-term care (because during the first two years of care you’re just spending your own assets). And you would only get the full benefit from the rider if you need at least six years of long-term care.

Are Long-Term Care Annuities a Good Idea?

Whether or not you should buy a long-term care annuity depends on your circumstances.

First and most obviously: the more likely you are to need long-term care (and, specifically, a long period of long-term care), the more valuable a long-term care annuity might be.

Then there’s the question of your assets. If you have enough assets that you could pay out of pocket for long-term care without too much of a challenge, it’s usually undesirable to buy insurance against LTC risk (because, on average, insurance is a losing proposition for the purchaser, given that the insurance company prices it so that it will be profitable to them).

And on the other side of the spectrum, if your assets are low enough that Medicaid would kick in after just a couple years of long-term care, it’s probably not a good idea to buy insurance against LTC risk, because doing so isn’t protecting you from financial risk so much as protecting the government against financial risk.

In other words, it’s people in the middle asset range who are more likely to benefit from insuring against LTC risk (either through buying traditional LTC insurance or a long-term care annuity).

One potentially important point regarding LTC annuities is that they often have less thorough underwriting than regular LTC insurance. That is, a person who wouldn’t qualify for regular LTC insurance due to a medical condition might be able to qualify for a LTC annuity.

Another difference relative to traditional LTC insurance is that long-term care annuities (or life insurance products with LTC riders) can work as a sort of “high deductible” LTC policy, in that they don’t start paying until you’ve needed years of long-term care.

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