Many high-net-worth individuals believe they can "self-insure" for long-term care (LTC) expenses. However, self-insuring is not true insurance, as it lacks the immediate leveraging of funds that traditional insurance provides. While self-funding is possible, it may not be the most efficient use of assets, especially for those seeking to preserve wealth and minimize estate taxes.
Challenges of Self-Funding
Self-funding LTC presents two key challenges:
- Unpredictability: Market fluctuations and the unpredictable timing of LTC needs to make it difficult to estimate the required funds accurately.
- Estate Tax Implications: For high-net-worth individuals, self-funding LTC within their estate can lead to significant estate tax liabilities, potentially diminishing the inheritance to heirs.
A More Strategic Approach: Linked Benefit LTC Policies and Irrevocable Life Insurance Trusts (ILITs)
A more strategic approach combines a linked benefit LTC policy with an Irrevocable Life Insurance Trust (ILIT). This strategy offers several advantages:
- Maximum Leverage: Linked benefit policies provide maximum LTC coverage with a guaranteed premium.
- Death Benefit Protection: The policy includes a death benefit, ensuring that the premium is not lost if LTC benefits are never or minimally used.
- Estate Tax Efficiency: Placing the policy within an ILIT can help reduce estate taxes, as the death benefit and any accrued loan interest can be excluded from the taxable estate.
How it Works
- ILIT Creation: An ILIT is established with provisions allowing for fully collateralized loans.
- LTC Policy Purchase: The ILIT purchases a linked benefit LTC policy.
- LTC Claim: When LTC is needed, the trustee files a claim.
- Loan to Grantor: The grantor borrows funds from the trust, using assets as collateral.
- Interest Accrual: Loan interest accrues. Ideally, the loan interest would be repaid before death to avoid income tax for the trust.
- Estate Tax Reduction: At death, the loan principal and unpaid interest are repaid to the trust, reducing the taxable estate and potential estate tax liability.
Example
A 60-year-old female could gift $196,032 to an ILIT, which would purchase a linked benefit LTC policy with a $1,080,000 benefit pool. If LTC is needed, the grantor borrows from the trust, repaying the principal and interest at death. This strategy could potentially save $123,833 in estate taxes and provide an additional $72,000 death benefit to the trust.
Benefits
- Tax Savings: Reduces potential estate taxes.
- Asset Protection: Protects assets from creditors.
- Liquidity: Provides immediate funds for LTC expenses.
- Legacy Planning: Ensures efficient wealth transfer to heirs.
Conclusion
For high-net-worth individuals, a well-structured LTC plan is crucial for both personal and financial well-being. By combining linked benefit LTC policies with ILITs, individuals can access care, protect their assets, and minimize estate tax liabilities, ensuring a more secure financial future for themselves and their loved ones.