So, you want to “self-insure”

It’s funny – not too long ago, you hardly ever would have seen “plan for your healthcare costs” on the retirement planning checklist.  Today, more and more advisors, wealth managers, and financial professionals are including “healthcare costs” in their planning conversations.

Here is where things go sideways.  They talk about the risk then dismiss the risk by saying something like, “…you have enough money, you can self-insure”.

I have a few problems with this whole thing.  But, I want to talk about one aspect of “self-insuring” – efficiency.

Before I get too far, I want to share my opinion that there is no such thing as “self-insuring” a long term care risk.  The accurate term is self-funding.  Without a transfer of risk, there is no insurance in the strategy.

Said another way, self-funding is pure risk retention. 

With this in mind, another point, if you are going to recommend a client to “self-insure / self-fund”, at least carve out a bucket of assets to use as a funding vehicle. 

Let’s say your clients are in their late 60s and have a chunk of money sitting in 2 or 3 nonqualified deferred annuities that are not intended to be used as part of their income strategy.  In fact, they’ve earmarked it as their healthcare emergency fund and the balance sits at $500,000. 

Let’s also assume that the basis of the $500,000 is $250,000.  As you know, the $250,000 of gain will be taxed at distribution.  Since the couple is only in the late 60s, let’s assume that 10 years passes before one of them experiences a situation where they would require extended care services.  At that time, assuming 5.00% compound interest, the annuity values would have grown to $823,504. 

Here is an alternative that will provide a similar bucket of money but without the tax implications.

Reposition a portion of the annuity money into the “self-insurance / self-funding” bucket using Annuity Care where they will go to pay for their extended care. 

In this case, let’s move a portion of the annuity money into Annuity Care I – say $300,000. Any time the monies in the annuity are used to pay for long term care support and services, they are received tax-free! 

In 10 years, assuming a guaranteed accumulation of 4.25% for the first 5 years then 3.00% thereafter, our couple would have a bucket of $428,240 of tax free.

Since we are only allocating $300,000 to the extended care payment part of the bucket, the remaining $200,000 can continue to grow tax deferred.  In 10 years, at a compound rate of 5.00%, the end of year balance would be $325,779.

Let’s look at how the pools of money look compared to each other.

Let’s say that they incur monthly expenses of $10,000.  Recognizing that the distribution is coming from a tax deferred vehicle via withdrawal and not annuitization, the distribution will be grossed up to $12,000 a month to account for taxes (assumed to be 20% for this example).  That amounts to $432,000 pulled from the annuity.

If this were to happen for 3 full years starting in year 10 and ending at end of year 12, the annuity value would be reduced by almost half leaving about $450,000 in the annuities. 

Remember, those distributions will have an impact on their overall taxes as well as means tested programs such as Medicare where premium surcharges might be incurred. 

In the case using Annuity Care, for the same 3 years of distributions to pay for care, only $360,000 would be needed from Annuity Care.  And, the unused money in it (Annuity Care) will remain in the policy and continue to grow until it is needed – just like the “growth annuity”.  In fact, the “growth annuity” would have balance of $395,986 at the end of year 14 assuming a 5.00% annual compound rate.

Combined, the strategy using Annuity Care along with the “growth annuity” after the 3 years of distribution have a balance of approximately $515,986.

As you can see from the comparison.  A dedicated bucket of money with an Annuity Care part performs from a growth perspective decently in comparison to the existing annuity program dedicated to the “self-insuring” model using deferred annuities.

Where it separates itself is when monies are needed to pay for long term support & services.  “Self-funding” creates a taxable situation while the Annuity Care strategy makes it tax free.  And, at the end of the day, after a modest 3 year claim, both strategies end with close to a half million dollars in their respective pools.

However, one of them provided money that did not impact their taxes or increase their expenses for Medicare programs.  That solution was the one that included Annuity Care.

So, for those people who believe that they can “self-insure”, there is one way to improve their play by simply using a dedicated bucket strategy that includes Annuity Care as an enhancement to their plan.

As always, if you need help, reach out to either Justin Fox or me.