If someone is self-funding their care needs in old age, there are two ways that care can be paid for: out of income or out of capital. If you are paying out of capital, the costs could use it up faster than you think. Richard Watkins, financial planner at Close Brothers (a leading merchant banking group providing lending, deposit taking, wealth management services and securities trading) says that even for wealthy people, care bills are "likely to be very painful". Nicola Bywater, a financial planner with Wealth Planning specialist Sanlam, says the most heart-breaking aspect of her job is hearing from elderly people who have lost a lifetime of hard-earned wealth because they have underestimated the cost of care.
She says: "If you're someone who is used to having choices in life, you don't want to get to old age and find you can't afford to choose how or where you are cared for in the final years of your life. Planning ahead and making sure you have enough to cover the worst eventuality will give you choice - as well as peace of mind."
Many people only start to look at options to address care costs at the time when the need is ‘real and present’. If they don’t want to simply use their capital or income to fund the costs, the solutions that are open to them at that stage tend to be restricted.
Two such options are annuities and equity release.
Immediate care plans (also known as immediate needs annuities or care fees annuities) come into operation when someone is already in care or is in a position where long term care is unavoidable. The plan pays out a guaranteed income for life to help cover the cost of care, in exchange for a one-off lump sum payment. Significant lump sums are usually required to provide the income to meet care costs. In most cases, the lump sum is likely to come from the sale of a property or investments.
As an example, after taking into account his pension income, Jack needs £20,000 a year to meet his care costs. Simplistically, an insurer will ask Jack some medical questions and might charge a £100,000 premium in return for paying the £20,000 for the rest of his life. Jack may die before five years, but may live considerably longer. The risk is that many people taking out immediate care annuities die before they have received enough income to justify the one-off payment.
Some advisers question the value of these products, but they can offer peace of mind, allowing families to insure against running out of money.
Equity release schemes are not used exclusively to fund long term care but, because they are designed to generate additional income, they can be used for this purpose.
There are two main types of scheme:
- lifetime mortgage arrangements
- home reversion plans (where part or all of the property is sold)
Equity release schemes can be useful, but only if the individual is looking to fund care in their own home. If they are likely to move into residential care, equity release may not be suitable. This is because many equity release arrangements have a clause requiring the holder to sell their property and repay the loan in full if they move into a care home permanently.
A more proactive approach
An alternative approach is to take the bull by the horns before care becomes an issue. A financial adviser can help clients look into investment and insurance-based options and recommend suitable solutions.
- Any growth in an investment in the years before care is needed can help to fund future liability to care costs. Additionally, for certain qualifying investments, the investment fund could also be exempt from inheritance tax (IHT).
- Using a pre-funded investment strategy also has the benefits of being extremely flexible, caters well for all potential outcomes, does not suffer the complexities of medical underwriting or medical assessments and is open to individuals of any age.
- Pre-funding by using insurance contracts is another way to remove some of the risk to a clients’ capital and has the advantage that clients can control costs by tailoring the benefits to the level of care needed.
Whist investment and insurance options for care are by no means new, it’s worth clients seeking out financial advice now to help mitigate the impact that self-funding care would have on clients’ income and capital.