Life Insurance… Now for the living! Part 2: Chronic Illness

The author discusses the most tax efficient options for Long Term Care insurance that are available to federal employees.

In the first article of this series, we learned that Living Benefit Riders are additions to a life insurance policy that allow the policy owner to accelerate a portion of the Death Benefit during their lifetime in the event of a qualifying emergency. Holistically designed life insurance plans coordinate Living Benefit Riders that provide access to tax-efficient emergency funds by “accelerating” some or all of the policy’s Death Benefit.

In this article, we will continue to explore the ways in which Living Benefits are utilized and the real world application of these features. For this conversation, though, the emphasis will be finding the most tax-efficient manner to provide for Long Term Care and discuss the different options commonly available to today’s federal employees.

Now, we could spend hours getting lost in charts and statistics about how quickly the American population is aging, how dramatically the cost of Long Term Care is increasing, and how much worse that cost will get as Nursing Homes and medicine continue advancing – prolonging our lives (and nursing home stays) even further. We could talk about how aging is not a “potential” concern for some portion of the population but an eventual concern for each of us.

But I think we are all comfortable with the general assumption that at some point in retirement, we are not going to be as independent as we once were and that finding assistance/care is neither cheap nor easy. Is that a fair enough starting point for us?

Now let me ask, are you a nurse, a doctor, or some other medical professional? Are you certified to provide care for another? Do you have 8-12 hours a day of extra time to fill?

Most of us cannot check yes to all of those questions, but if you are amongst the few that could, are you financially able to provide that care for free? Can you afford to set your career on hold or sacrifice your income to tend to an ailing relative? Do you have a loved one that is ready to check each of those boxes when your independence is eventually diminished? Not many of us do. So how do we design a plan for aging gracefully in the real world?

The traditional answer to these questions would be with Long Term Care Insurance. This traditional approach comes with the traditional issues though in that traditional LTC plans are expensive, have very specific rules both for qualifying to receive the benefit and how the benefit is actually used, and come with some other lesser-known caveats.

Lets first look at the restrictive nature of LTC policies. LTC policies are only designed to protect you from one specific scenario, the need for professional Long Term Care. In addition to having a very small number of qualifying triggers, most LTC policies have very specific approved uses for the benefit, which means that the real world application of LTC benefit funds is actually even more restricted!

These policies are generally designed under a “reimbursement” model, meaning that your benefit is only released to reimburse you for services received from a licensed medical professional.

That is a very narrow scope of coverage, isn’t it? LTC plans are meant to help us age gracefully yet the “reimbursement mode” still requires each bill be submitted and approved before the insuring company disburses any benefit funds at all. Generally there are not any exceptions for using the LTC benefit towards secondary expenses that accrue for someone who has lost or is losing their independence, such as backed up bills, reimbursing family members for time/help, or alternative medicine practices.

If you needed help around the house, who would you trust more when your capacities diminish: a family member or a stranger? Who would you rather spend your golden years seeing each day – a relative or a company representative? Which option do you think cost less: reimbursing a family member or paying an invoice from a trained professional?

Another concern with LTC, above the cost and multiple layers of restrictions, is that most of the policy types out there fall under the “use it or lose it” design. This means that the ONLY way you receive any benefit is to receive licensed medical care and submit the bill for reimbursement or go into an approved nursing home. This “use it or lose it” design is very much like the cancer policies discussed in last article, meaning that not only is it expensive but it is also a gamble as to whether or not you ever qualify to see a penny!

Lets look at these 3 Custom Plans for FLTCI to give a more specific example of the “use it or lose it” risk. Below, look at the actual cost for the 3 following Federal Long Term Care Insurance plans quoted to a 57 year old client.

Gap Analysis Report
Date of Birth 12/5/1958
Current Age 57
Plan Options
Illustration Number #1 #2 #3
Plan Type Custom Custom Custom
Daily Benefit $250/Day $350/Day $400/Day
Benefit Period 3 Years 3 Years 3 Years
Waiting Period 90 Days 90 Days 90 Days
Inflation Protection 4% ACIO 4% ACIO 4% ACIO
Premium Frequency Bi-Weekly Bi-Weekly Bi-Weekly
Premium Benefit $109.63 $153.48 $175.41
Maximum Life Benefit $273,750 $383,250 $438,000

Now, if you opted to take the 2nd option, you would have a maximum total lifetime benefit of $273,750, but you would start paying $109.63 bi-weekly at age 57. If you continued to pay that $2,850 each year up until age 79 (the avg. age of nursing home admittance), then by this point you have put out a lot of money, most of it being paid from your retirement income. Lets say you keep the plan until age 79 and on the way to admitting yourself to the nursing home you get hit by a bus. There is no nursing home benefit to receive if we are no longer alive to receive it, so what happens to all of our premium payments?

Traditional LTC doesn’t provide any death benefit, and unless you pay more for a Return of Premium Rider, then the funds you paid into the LTC policy will go towards paying for someone else’s long term care. That totals $62,708 over that time… all gambled on whether or not you would ever qualify to receive any LTC benefit at all!

How much would that LTC policy pay out if you got cancer, or ALS, or if you went blind? How much of that $60,000 could you borrow from your LTC policy if you needed to get your hands on some extra cash? Now that we have put it in perspective, are you personally comfortable taking the “use it or lose it” gamble with $60,000?

The key to properly designing elder care protection, in a world where the future is so unpredictable, is utilizing strategies that emphasize flexibility. Properly designed retirement plans feature the most efficient strategies for providing flexible benefits at the lowest total expense. This is where Life Insurance comes back into the discussion with its flexibility and tax efficiency.

There are 2 approaches to incorporating LTC in a life insurance plan.

First, there are “Hybrid Plans”, which fall under the IRS 7702B classification, meaning that policies featuring these riders are designed with the primary emphasis on providing for Long Term Care and a secondary feature of providing a small Death Benefit. These strategies follow the aforementioned “reimbursement” model, and while they add a moderate amount of flexibility, through the inclusion of a small Death Benefit, they are still designed to fit that niche of providing specifically for professional LTC.

The second approach is the most flexible, in it we add a “Chronic Illness Rider” to a life insurance policy. In these plans, the emphasis is on providing the Death Benefit that you need in order to protect your family, while simultaneously allowing you to tap into that Death Benefit during your lifetime in the event that you cannot do 2 out of the 6 activities of daily living.

Policies with “Chronic Illness Riders” fall under the 101(g) IRS classification, meaning that instead of the “reimbursement” model, funds from these riders fall under the “indemnity” model meaning the entirety of your benefit is paid to you directly with no relation to the services received. This means you do not have to submit each bill for reimbursement and have no strings attached to how you utilize those funds.

If you need to replace your spouse’s income for them stay home and help you… you can. If you knew a carpenter at your church, with this model you can choose to have them be the trusted individual to renovate your home. Once you qualify for the benefit, you decide how you spend the funds – whether that be on professional care, trusted family care, home improvements, or even crossing the last items off of your bucket list!

The verbiage and actual formula for calculating a Chronic Illness Rider vary by company, policy type, and even geographical location, but these riders are generally added to a life insurance policy at no cost to the owner.

While the final benefit payout varies based on those factors previously listed, there is a general rule of thumb for approximating a Chronic Illness Benefit. Most companies allow the policy owner to accelerate up to 24% of the Death Benefit for up to 4 consecutive years.

As a means of providing this rider for free, when they accelerate that portion of the Death Benefit, they then use your age as a percentage to calculate the amount of the accelerated death benefit you actually receive. A hypothetical example of a $300,000 life insurance policy being accelerated is as follows:

Age % Accelerated Amt Accelerated Discount Factor


Tax Free Benefit Remaining Death Benefit
75 24% $72,000 75% $54,000 $228,000
76 24% $72,000 76% $54,720 $156,000
77 24% $72,000 77% $55,440 $84,000
78 24% $72,000 78% $56,320 $12,000

So for a grand total of $0 additional premium dollars, this feature allowed you early access to $220,480 of tax-free benefit while still providing a tax free death benefit of $12,000 after you pass away.

If we go back to the FLTCI example above, it would cost us an additional $109 bi-weekly, starting at age 57, in order to purchase a maximum lifetime Long Term Care Benefit of $273,000.

In addition to that FTLCI, you would have to continue paying the continually increasing premiums for $300,000 of FEGLI coverage. Even then, when you are paying premiums for 2 policies, you still only have coverage if you die or receive a bill for professional long term care.

Think back to the first article in this series to remind us that our custom designed life policy also has the other Living Benefit Riders. This life policy allowed those same premium dollars to be used more efficiently to provide similar benefits to the FTLCI while still providing for other illnesses.

In addition to the other living benefits (Terminal Illness, Critical Illness, and even Critical Injury), you still have the Death Benefit for if you never end up needing long term care.

Does it make sense to pay an additional $0 on the cost of your normal life insurance policy in order to receive all of these extra benefits? Does that policy design check the box for efficient use of your premium dollars? Does it check the box for the policy flexibility we need to make a holistic retirement plan? Does it make sense to have your premium dollars double and triple utilized to provide all of these benefits or would you rather gamble by paying for each policy separately?

About the Author

Tom Walker is the founder of Walker Capital Preservation Group, Inc. He believes strongly in empowering today’s federal employees through benefits education at retirement workshops and through featured publications. He has compiled many greatly informative resources on his website, and WalkerCPG Facebook page.