Long-term care is expensive. The median annual cost in 2019 for assisted living services was $48,612, according to Genworth’s Cost of Care survey. A private room in a nursing home was more than double that. These high costs prompt many people to purchase long-term care insurance.
However, even if you don’t have long-term care insurance, you can still use your or a loved one’s current life insurance policy to help pay for long-term care. “If seniors don’t have a long-term care plan in place, the cash in your life insurance policy is a great place to start,” says Sam Price, an independent life insurance broker and owner of Assurance Financial Solutions.
Before you figure out whether your life insurance can help pay for long-term care, you need to understand what kind of policy you own. Here’s a quick overview.
Now let’s look at some options to free up money, depending on your type of policy.
With a life settlement, you sell your life insurance policy to a third party for market value and use the proceeds to fund a long-term care benefit plan. Any type of life insurance — permanent with cash value, group insurance offered through an employer, even term life — can be used. However, most companies specializing in these transactions require a minimum of $50,000 in a death benefit.
If you’re going to do a life settlement, it’s best to wait until you actually need long-term care, says Nicole Gurley, owner of Gurley LTCI, a brokerage company specializing in long-term care funding solutions. “Generally, the shorter the life expectancy, the larger percentage of the death benefit will be paid to the insured,” says Gurley.
For example, if someone with a $100,000 death benefit is 90 years old and needs long-term care, they could sell the policy and possibly receive as much as $60,000 of the death benefit. That amount is deposited in an FDIC-insured, irrevocable bank account and professionally managed by a licensed benefit management company that specializes in the payment of long-term care benefit plans on behalf of the person needing care. The administrator then makes payments directly from the bank account to the home care agency or assisted or skilled nursing community providing long-term care.
When you “surrender” a life insurance policy to the insurance provider, you’re giving up ownership and the death benefit. If the policy has accumulated cash, the insurance company writes you a check for the full amount of cash value. In many cases, you must pay taxes on that amount — but not always.
“If the cumulative premium amount paid over the life of the policy is more than your current cash value, there are generally going to be no taxes,” says Price. “However, if you’ve had the policy for several years and the cash value has grown beyond the premiums paid into the policy, then you’re going to owe taxes on the gain.”
Many companies differentiate between “cash value” and “surrender value,” so those amounts may differ in the early years of the policy. Insurance companies may penalize a policyholder who surrenders a policy early on. Also, if you plan to use Medicaid to pay for long-term care, the cash portion of your life insurance policy — or the amount you receive when you surrender the policy — can be considered an asset and count against you for Medicaid eligibility.
“Generally, permanent policies with cash value can count toward Medicaid eligibility when the death benefit is more than $1,500,” says Price. Term life insurance, which has no cash value, won’t count toward Medicaid eligibility.
You won’t have to pay taxes on cash received from your life insurance if you take a loan from the policy’s cash value. You can’t take it all, or the policy will lapse. However, you can usually take most of the cash value in a loan that you pay back to yourself with interest.
“If your health care needs are more than the money you have in the policy, you’re going to surrender the policy because you need every dollar,” says Price. “However, if your needs are less than the amount of cash value, then a loan might make more sense. That way, you can keep some portion of the death benefit in place.”
If you have time to plan and want to avoid paying taxes on funds received from your current life insurance policy’s cash value, you may be better off doing what’s known as a 1035 exchange. This conversion allows you to exchange one insurance policy’s cash value into a new policy without paying taxes on the money.
The 1035 transaction also allows you to exchange cash value from an existing life insurance policy into a new life insurance policy with long-term care insurance benefits tax-free. For example, you could use the cash value to fund premiums on a hybrid policy, which includes life insurance, long-term care benefits, and even “living” benefits for costs related to strokes, cancer, or illnesses that long-term care insurance may not cover.
“Sometimes, that’s a convenient way for people to fund long-term care insurance, because the premium is not coming out of household income,” says Gurley. “You just take the cash value in an old policy and move it to a new policy that offers long-term care benefits.”
Before you make any decisions about using your life insurance policy to help fund long-term care, make sure you consult a qualified life insurance or financial adviser.