Life Insurance as a Planning Tool for the Final Years of Life
May 1, 2018 | by the National Care Planning Council
Life insurance companies have become more competitive in recent years for policies issued on people over age 70. Good health is still a major consideration for low premiums but policies have been redesigned to provide more death benefit and less cash value. Some term policies can guarantee a death benefit up to age 85 with a level premium. Certain universal life policies can be designed to provide a guaranteed death benefit beyond age 100 with a guaranteed premium and virtually cash value at all. This design generally results in more death benefit for each premium dollar. Also, policies designed for couples--second-to-die policies--can provide a significant amount of insurance for a one-time single premium even if one of the partners is in very poor health.
Life insurance can be used as an alternative for funding the cost of long term care. If someone planning for the eventuality of long term care is concerned about losing assets that would normally be passed on to the children or be needed by a surviving spouse, that person can invest a portion of those assets in life insurance and leverage a death benefit payout--sometimes for up to $3.00 in death benefit for every $1.00 in single premium. The death benefit is also income tax-free.
A person creating such an estate can then use remaining assets for long term care needs in the future but still be assured that the children or a surviving spouse will receive an inheritance at death through the life insurance. And, as discussed above, if the money runs out and Medicaid has to start picking up the costs, a single premium life insurance policy with little or no cash value will not disqualify the applicant owning the policy
Another use for life insurance for the elderly is in paying the cost of final expenses such as funeral and burial. A number of companies will issue policies without any health questions for people who may not have very long to live. Most of these policies will provide little or no death benefit in the first two years after issue and so there is some risk, but most companies will also return the premiums paid if death occurs in the first two years.
An important concept to consider is that single premium life policies, with no cash value and purchased for estate planning purposes, many years in advance of applying for Medicaid, can be a valuable planning tool if the need for Medicaid arises. Medicaid does not apply the death benefit of a life insurance policy to the asset spend down rule. But the cash value of all policies owned – if any policy has more than $1,500 in face value – will count towards the asset test and could disqualify a Medicaid applicant unless the policy is cashed in through cancellation.
It is important to know, for planning purposes, that people who apply for Medicaid and then transfer assets to a life insurance policy, while they are going through spend down, could be in violation of their state's Medicaid transfer rules and such an act would likely disqualify the applicant. Life insurance as a Medicaid planning tool must be done a reasonable period in advance of applying for Medicaid.
Medicaid Funeral Trusts
Most states allow for money to be set aside for paying the cost of funeral and burial and this money is exempt from the spend down requirements to qualify for Medicaid. These states allow cash to be put into an irrevocable trust that has a sole purpose of paying for funeral and burial expenses. As long as the trust meets the structural requirements from the state, trust assets can be used to pay for funeral and burial. All states have a limit on how much money can be set aside. In addition, many states require that the trust also contain a list of so-called "goods and services" that specifically lists the funeral and burial costs for which the money will pay. In all states, if not all of the money is used for funeral and burial, the remainder of the money goes to the state instead of to the family.
A life insurance policy that has two much cash value and might have to be cashed out in order to meet spend down requirements, can be transferred into one of these Medicaid funeral trusts with the state having an assignment of the death benefit that exceeds the cost of funeral and burial. This is a great way to preserve the death benefit of the policy. On the other hand, if the death benefit is too large, the cash that is not used for funeral and burial will go to the state instead of to the heirs. Naturally, if Medicaid is never needed, then at the death of the person covered by the insurance, the death benefit will go to the alternate beneficiaries listed on the policy.
Income Annuity or IRA Withdrawals to Buy Life Insurance
Tax qualified investments such as IRAs, 401(k)s, Tax Sheltered Annuities and other plans are great for saving taxes while one is working but many seniors find they don't need that money during retirement and they may want to pass on some of this tax sheltered money to their children. New "stretch IRA" rules have made it easier to reduce the immediate tax burden on these transfers at death but income tax that was deferred must still be paid. The income tax on these transferred assets can eat up a significant portion of the investment.
One way to create a tax-free transfer at death is to convert the IRA or 401(k) into a life annuity income while the owner is alive and use part of the income to purchase a life insurance policy that would equal the amount of money in the IRA -- intended as an inheritance. A life insurance death benefit is income tax-free and thus the loss of a significant part of the account to taxes has been avoided.
Reverse Mortgage Life Insurance Strategy
Some older people don't like the idea of doing a reverse mortgage because they feel they are robbing their heirs of an inheritance or there is something inherently wrong in using up the equity in the home.
A useful strategy that typically appeals to these people is to take part of the reverse mortgage proceeds and buy a life insurance policy that has a death benefit equal to the amount of equity taken out by the reverse mortgage. A couple in their 70s could possibly buy an insurance policy for $50,000 that would pay $150,000 at the last death.
The reverse mortgage produces $150,000 in available funds. After buying the insurance, there is $100,000 in funds still available. But when the couple dies the family inherits $150,000 tax-free to replace the loss in equity to the reverse mortgage.
