There are many ways to pay for long-term care, including long-term care insurance, health savings accounts, Medicaid, trusts, reverse mortgages, and personal savings accounts. You can also use annuities to pay for long-term care.
What are annuities?
Annuities are contracts issued by insurance companies that require them to make immediate or future payments to annuitants in exchange for either a single payment or a series of payments over a specified term.
There are three main reasons why people buy annuities:
- To supplement their income in retirement and to help pay for long-term care with periodic payments over specified amounts of time
- To award death benefits to beneficiaries should annuitants die before receiving payments
- In order to enjoy tax-deferred growth on annuity investments
The life of an annuity is split into two phases:
Accumulation phase: An annuitant makes payments to an investment company, which puts payments into investment options to grow.
Payout phase: The insurance company pays the annuitant whatever they paid during the accumulation phase plus investment gains and income.
Types of annuities
There are three main types of annuities:
With fixed annuities, insurance companies guarantee the investment principal and offer minimal interest rates, protecting investments from market fluctuations.
With variable annuities, insurance companies allow annuitants to put payments into whatever investment options they want, exposing investments to market fluctuations. Income payments vary depending on portfolio performance.
With indexed annuities, insurance companies make payments tied to stock market indexes, producing payment amounts that vary more than fixed annuities but less than variable annuities.
Payout options
Annuities also belong to either of two groups defined by payout option:
Immediate annuities: Annuitants receive payments within a year in exchange for a lump sum payment to the insurance company.
Deferred annuities: Annuitants receive payments during a future payout phase, with investments building tax deferred.
Annuities to pay for long-term care
Some deferred annuities come with long-term care riders, side benefits that offer additional protections for long-term care. These are called long-term care annuities, which are a cross between traditional deferred annuities and long-term care insurance.
Annuitants pay for insurance coverage with assets — usually lump sums — not premiums; and choose how much coverage they want for long-term care, which is usually 200 percent or more of their annuity principal; and determine how long their coverage lasts.
Advantages
Since annuitants make a single payment up front for their long-term care annuities, they don’t have to worry about premium increases.
Additionally, with long-term care insurance, policyholders can lose coverage if they forget or stop making payments. By comparison, annuitants won’t lose coverage once they’ve paid their initial lump sum, and they don’t have further payments to worry about. Withdrawals from long-term care annuities for long-term care expenses are generally tax-free.
But perhaps the biggest advantage to long-term care annuities is that annuitants won’t lose their investment if they don’t need long-term care, unlike long-term care policyholders, some of whom pay premiums for years and never end up using coverage.
Disadvantages
To buy a long-term care annuity, annuitants need at least $50,000 to invest up front, and they won’t be able to access that money penalty-free for at least 10 years. (Early withdrawal penalties can be as high as 10 percent.)
Long-term care annuities sometimes don’t earn as much return as other annuities. And, finally, annuities don’t qualify for partnership plans, which allow policyholders seeking Medicaid to retain their assets.
The bottom line
Using an annuity to pay for long-term care may be a smarter option for you than buying long-term care insurance if you aren’t sure whether yourself or a loved one will need long-term care in the future. With an annuity, your investment plus investment gains are paid back to you during the payout phase, whether or not you need long-term care. For more on long-term care, check out our comprehensive guide on understanding the costs.
