The crisis surrounding nursing homes during the pandemic has prompted a dramatic awakening around the need to better plan for long-term care and aging-in-place options.
Historically, long-term care planning has been the “can kicked down the road” due to the costs and complexity of insurance products. The “backup plan” has been to self-fund if you have sufficient resources, or if not, to rely on government programs such as Medicaid. However, the risk of isolation and exposure—which we have observed so widely in extended care facilities over the past year—has been a wake-up call for many to get serious about creating a viable long-term care plan. The cornerstone of that plan, both for the clients and financial advisors that we work with, is a firm desire to never end up in an institution, but rather to “age-in-place.”
Aging-in-place is a conscious decision to stay in one’s home for as long as possible, with the comforts and conveniences that are necessary and important to you. Thanks to the “shop at home” revolution, this is becoming easier now than in years past. Today we can order prepared meals, groceries, clothing, and just about anything else you can think of online and have it all delivered right to our doors—sometimes within hours.
Beyond the ability to have conveniences at home, aging-in-place requires planning for the possibility of long-term care, which insurance companies refer to as assistance with activities of daily living (ADLs). These can include feeding and dressing oneself, personal hygiene, and other functions. According to Morningstar’s Long-Term Care report from December 2020, 70% of people turning 65 today will require long-term care assistance at some point in their lives. Some of this will be provided by family members, but nearly 1 in 2 will require paid assistance.
The options to pay for that assistance include insurance-based solutions such as traditional long-term care and hybrid insurance policies, or self-funding—which generally means spending down personal savings. Another resource for self-funding often overlooked, however, is the use of home equity, which could provide a tax-efficient, convenient option to both age-in-place, and pay for any long-term-care needs.
These were extremely popular 20 years ago as you could purchase what seemed to be solid protection at a reasonable rate. Unfortunately, the insurance companies underestimated their exposure and policyholders have since endured double- or triple-digit premium increases. Policies issued since 2011 have been more stable in pricing, however, that stability comes at a much higher premium cost to the policyholder. Since traditional long-term care policies have no cash value or return of premium features, and no guarantees on premium pricing, consumers have increasingly backed away from them—with new issues dropping by 92% in recent years.
Hybrid policies are basically whole or universal life insurance policies combined with long-term care or accelerated benefit riders. These are growing in popularity with consumers and financial advisors as they can accumulate a cash value or a death benefit—providing a return to the heirs if the long-term care riders are not fully or partially used. Because of the life insurance benefits, however, they are more expensive than traditional long-term care policies.
Self-funding a long-term care plan with personal savings could be a viable option for people who do not qualify for insurance products, or who feel their risk for long-term care is minimal. A careful evaluation would need to be made as to what resources are available, if those resources are generating current household income, and what would be the impact on a surviving partner if those resources were depleted by a substantial long-term care event.
Home equity is another self-funding option, but historically has been “off-limits” in terms of being included in a retirement plan. Part of that has simply been the desire to eliminate mortgage payments for budgeting purposes. The other part, however, was the lack of products to tap home equity in a safe and efficient manner.
Traditional options include a new mortgage or cash out refinance, but they require not only qualifying for a loan, but also monthly mortgage payments for up to 30 years.
HELOCS can also be a source of cash, however, in addition to requiring a monthly payment, in certain circumstances, they can be called, frozen or recast at the lenders option. This can happen when home values deteriorate as in the Great Recession of 2008. In such cases, counting on a HELOC for in-home care expenses could leave you high and dry just when you need it the most.
For homeowners 60 and older, reverse mortgages can efficiently access home equity. They were previously discounted due to reputational issues, but with new consumer safeguards added in recent years, financially savvy consumers and advisors are now taking a second look at them.
The key attraction with a reverse mortgage is access to income-tax free cash, with no required principal or interest payment for as long as the borrower is living in the home.
Products include both FHA-insured home equity conversion mortgages (HECMs), and lender-specific reverse mortgages, with loan amounts as high as $4 million. Loan proceeds are available in multiple options, including cash, guaranteed payments, and lines-of-credit. If there is an existing mortgage on the home it would be paid off by the reverse, giving an immediate boost to household cash flow as the monthly mortgage payment would be eliminated. Although there are no monthly payments required on a reverse mortgage, borrowers are still responsible for paying taxes and insurance on the property and must also maintain the property. If the borrower does not meet these and other terms of the loan, it will need to be repaid.
The FHA product has a unique line-of-credit feature that includes a growth rate, which increases the available credit monthly based on a factor tied to current interest rates.
We recently used this as a long-term care plan for a couple in their early 60s with a $650,000 home. Based on their age and home value, they were eligible for a credit line of nearly $320,000, which if left alone will grow to $500,000 or more by the time they are in their mid-80s.
They now have a plan in place to manage long-term care expenses if needed, without having to leave their home, deplete their invested assets, or spend thousands of dollars per year in premiums for an insurance plan.
A lender-specific reverse mortgage can provide a great opportunity to incorporate higher valued properties in a long-term care plan.
Another couple we worked with wanted to stay in their current home for as long as possible. However, they realistically felt that when one of them passed on, the other would move to an apartment or assisted living facility. For this reason, an insurance-based long-term care plan was the best solution—as they could receive benefits wherever they lived. However, paying for that solution would put a dent in their current household budget which included $5,500 per month in principal and interest payments on their existing $1 million mortgage balance.
By refinancing that loan with a lender-specific reverse mortgage, they were able to pay off the existing loan, eliminating that required monthly payment. They now have the extra cash flow to not only pay the premiums on their insurance-based long-term care plan, but to boost their retirement savings as well.
Reverse mortgages also have a reputation for being an expensive loan. The reality is, the closing costs are basically the same as with any other mortgage, with one exception. The FHA product has an upfront mortgage insurance premium, which is 2% of either the appraised value of the property or $822,375, whichever is less. In our example of self-funding with a $650,000 home, that would equate to a $13,000 upfront mortgage insurance premium.
While that may initially seem expensive, it can be very cost effective considering it is a one-time fee, which can be financed in the loan (note that FHA also charges an annual mortgage insurance premium of 0.50% of the outstanding mortgage balance). That opens the door to hundreds of thousands of dollars if needed to manage long-term care expenses.
No matter how fit we are, how well we eat, and how often we exercise, aging is inevitable. And while we are living our best life, we still need to plan that one out of every two will pay for long-term care assistance at some point in the future.
Careful consideration needs to be made of all pertinent factors—including family support, desired living arrangements, and the financial resources available to make it all happen. Once everything is thoughtfully evaluated, a plan can be made to take control of your future care and housing considerations, thereby providing peace of mind for your retirement.
Stephen Resch is the vice president of retirement strategies at reverse mortgage lender Finance of America Reverse LLC. The views expressed in this article are those of the author alone and do not necessarily reflect the views and opinions of his employer. This article is not intended to provide financial planning, wealth management or tax advice. For tax advice, please consult a tax professional.