Should Some Clients Self-Fund for Long-Term Care?

Ethan Young
Ethan Young

01.03.24 in Wealth Planning & Investing

Estimated Reading Time: 2 Minutes (315 words)

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Commonwealth partnered with Ash Brokerage to enhance the insurance marketing and operations functions available to our advisors. We worked closely with the specialists at Ash Brokerage to bring you this post.

Without a plan, a long-term care event can quickly derail a client’s income, retirement, and legacy. While the need for a plan is often clear, deciding on how to fund that plan can be a different story. Here, there are two distinct approaches to consider.

First, individuals or families may choose to self-fund (or self-insure) for long-term care, meaning they do not purchase long-term care insurance or any specific financial product. Instead, they rely on personal savings, investments, and assets to cover long-term care costs. The risk transfer is limited, as individuals retain all financial responsibility for their long-term care expenses.

Second, individuals can choose to purchase long-term care insurance or a linked-benefit policy, which transfers all or part of the risk to an insurance company. Conventional financial planning generally recommends transferring the risk of long-term care, even for high-net-worth (HNW) clients. And at Commonwealth and Ash Brokerage, our insurance partner, we would agree that there's some truth to this idea. But that doesn’t mean it's right for every HNW client.

So, how can you determine if your HNW clients, considering their distinct needs, should self-fund for long-term care? These five steps can help guide you through the decision-making process (click each heading to expand the section):

Faulty assumptions can cause a lot of harm. You may assume that every client with $5 million in assets (on the typical HNW threshold) should self-fund for long-term care without first discussing the issue with those clients. Or, perhaps your clients assume they have more than enough assets to self-fund, without understanding the true cost of a long-term care event. If you don’t check these assumptions, your clients may end up taking losses that can’t be recouped.

Although it might seem intuitive to use net worth as a gauge for a client’s ability to self-fund, income is the more accurate indicator. Many individuals use income to pay for long-term care expenses, so determining whether to self-fund should be a question of liquidity, not solvency.

self-insure for long-term care circle chart

Now, you may be thinking, can’t my clients sell assets from their portfolios to pay for long-term care? Indeed, they can. But liquidating assets can be expensive and may even jeopardize their overall financial planning strategies.

As clients drain their household income to cover long-term care expenses, they could reallocate liquid assets (e.g., brokerage and retirement accounts) to pay for their monthly needs. Of course, such transactions will have consequences, including tax ramifications and penalties. Plus, without these assets to drive it, your clients’ future retirement income could take a hit.

You should also consider the challenges of converting illiquid assets, such as real estate, into liquid assets. The sales could take significant time, lead to a significant loss, or result in tax consequences.

Costs for long-term care vary depending on where your clients live and the level of care they need. In Massachusetts, the monthly median nursing home bill for a semi-private room is roughly $12,623 (according to Genworth’s Cost of Care Survey for 2021). In 15 years, that number could increase to $25,000 a month (depending on inflation). Let’s see how this could play out through an example:

Bob’s monthly retirement income of $18,000 supports Bob and his spouse, Barbara. Their active lifestyle includes caring for their home, spending time with their extended family, and supporting their hobbies and charities. If Bob needs long-term care services at a cost of $13,000 per month, only $5,000 will remain to support the spouse's lifestyle.

Bob cannot spend an additional $13,000 per month—a figure that’s likely to rise—and still meet all his other financial obligations. So, he should consider other sources of long-term care funding, such as a long-term care insurance policy, to cover part of the future costs.

Most HNW clients have a legacy plan that dictates where they want their money to go after they die. By deciding to self-fund for long-term care expenses, they will undoubtedly affect their legacy plan. Monies they planned for family members or charities will now go to the health care system. Is this an acceptable scenario for your clients?

Planning for long-term care is about choosing what works best for your clients and their family. Most often, that won’t be a state-mandated plan. But as long-term care costs continue to rise? States are likely to look for ways to shift expenses back to the consumer. What happened in Washington State is a good example.

In 2022, the state started requiring that employers deduct a percentage of paychecks to cover employees’ future long-term benefits. Leading up to the mandate’s deadline, many advisors helped clients consider alternative options by looking into private plans. Unfortunately, carriers became overwhelmed with applications, and many clients couldn’t secure coverage in time to be exempt.

As other states consider similar mandates and the need for planning for long-term care persists for everyone, you may want to adopt a plan that can be customized to fit different clients’ needs and would allow them to opt out of state mandates.

Traditional long-term care insurance. Due to higher-than-expected claims costs, the traditional long-term care space has seen a steady erosion of available products and a sharp increase in pricing for both new and existing coverage. Lifetime benefits, once an option on most policies, have been replaced by much shorter benefit durations. The financial risks of extended long-term care events can certainly be mitigated with these plans, but no longer can they be eliminated. Even well-covered individuals may have to self-fund to a degree.

Life insurance policy with a long-term care rider. For clients who want to self-fund for long-term care but don’t want to reposition a large sum of assets, life insurance is a good alternative. A life insurance policy allows for annual premiums rather than single premiums. Plus, because the policy is underwritten, the death benefits tend to exceed those from linked-benefit products.

Linked-benefit products. These products combine the features of long-term care insurance and universal life insurance, making them attractive for clients who are concerned about paying premiums and then never needing long-term care. By repositioning an existing asset, they can leverage that money for long-term care benefits, a death benefit (if long-term care is never needed), or both. The policyholder maintains control of the assets, freeing up retirement assets for other uses. Here’s a hypothetical example of how this might work:

Nicole is an HNW client. She's 65 and married, and she previously declined long-term care insurance because she feels that she has enough money to self-fund, including $200,000 in CDs that she calls her “emergency long-term care fund.” You know, of course, that if she ever needs long-term care, this $200,000 won’t go far, and she may have to make up the shortfall with other assets.

Based on what we know about available products, their average benefits, and if Nicole is eligible for coverage, here is what she could gain if she repositions $100,000 to purchase a linked-benefit policy:

  • A death benefit of $180,000 (income tax-free)

  • A total long-term care fund of $540,000 (leveraging her $100,000 more than fivefold)

  • A monthly long-term care benefit of $7,500 (which would last for a minimum of 72 months)

  • A residual death benefit of $18,000 if she uses her entire long-term care fund

Care coordinators. Home care is often viewed as ideal by many clients but setting it up presents challenges. Both traditional long-term care insurance and linked-benefit insurance provide policyholders with care coordinators who can help facilitate this transition. These coordinators offer a very high-level concierge service, which can make a difficult time a little less stressful.

Sound Financial Planning

Ultimately, the choice to self-fund for long-term care depends on your clients’ financial situation, risk tolerance, and the level of financial protection they desire for potential long-term care needs. Starting the conversation as early as possible can help them make an informed choice—based on the available options—and keep their financial plan on track.

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Editor's note: This post was originally published in March 2019, but we've updated it to bring you more relevant and timely information.

This material is for educational purposes only and is not intended to provide specific advice.

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