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Do You Have a Viable Plan for Long-Term Care?

This type of insurance is pricey, but Medicaid is an imperfect fallback plan.

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Forget gas prices, college costs, and cable bills. If you want an example of skyrocketing inflation, look no further than long-term care insurance premiums, which have jumped between 6% and 17% during the past year alone, according to the American Association for Long-Term Care Insurance. Some existing policyholders have been confronted with the choice of swallowing higher premiums or accepting benefit cutbacks, and during the past few years major providers such as 
 Prudential Financial (PRU) and  MetLife (MET) have stopped writing new long-term care policies altogether. Not only are interest rates low, meaning the insurers can't earn much on the premiums and have to charge more to compensate, but insurers have had to cover larger claims for long-term care than they anticipated when they initiated the policies.

Given that inhospitable backdrop, many consumers are opting to go without long-term care insurance altogether. Wealthier individuals might decide to foot the bill from their own savings when and if they need long-term care. Less-affluent consumers, meanwhile, may conclude that forking over long-term care premiums simply isn't a good use of their assets if they're also behind on being able to meet basic needs during retirement, or they have missed the window to purchase long-term care at a reasonable price. (By the time a person hits his or her mid- to late 60s and might also be experiencing health issues, the policies can be exceptionally costly.) For such people, Medicare and Medicaid might be their only options should they need long-term care.

But Medicare only covers long-term care needs under a limited set of circumstances and for a short period of time. Qualifying for Medicaid, meanwhile, can be a devilishly complicated process, requiring an individual to exhaust most of his or her financial assets and also limiting the type of care that's available. If relying on these programs is your fallback plan, it's a good idea to understand the ins and outs of them well before you get close to needing them. Ditto if you help oversee your parents' finances and you expect they might have long-term care needs down the line.

Below are some of the key factors to bear in mind.

Medicare Not Much of a Safety Net
Many individuals assume that Medicare will cover their long-term care, taking comfort in the fact that Medicare benefits are not needs-based, so people don't need to deplete their assets to qualify. But there are actually tight limits on what type of care the program will provide and when. Medicare covers the first 20 days in a skilled nursing facility following a three-day hospital stay, provided the person needs skilled care; for the next 80 days, Medicare picks up a portion of the bill. It may also provide short-term home health care for those recovering from an illness or injury as well as hospice care for individuals in the last stage of a terminal illness. Medicare doesn't cover extended, open-ended long-term care--what's called custodial care to help an individual carry out basic activities like bathing, eating, getting dressed, and so forth.

What Medicaid Will (and Won't) Provide
Long-term care benefits are available through Medicaid to low-income individuals who can demonstrate financial need. (More on that below.) Those benefits do cover long-term care for an indefinite period, but you'll be limited to certain facilities, which might not be as geographically well-situated or have the same amenities as others. One other important limitation to obtaining long-term care coverage via Medicaid: In-home care, which many people prefer over moving to an external facility, is typically not an option.

Punitive Lookback Provision
For many elderly people, the big nightmare of long-term care is that paying for it could gobble up the financial assets they had hoped to leave for their spouse, children, or grandchildren. And unfortunately, qualifying for Medicaid requires seniors to spend down nearly all of their assets first. Specific rules regarding Medicaid eligibility vary by state, but in many states, allowable assets top out at around $2,000; individuals are typically also allowed to retain some level of home equity, often up to $500,000.

At first blush, acting preemptively to shield those assets, either by transferring ownership to a spouse, gifting to loved ones, or setting up trusts might seem like a good workaround. But even if you can get comfortable with the idea of taking extraordinary measures to qualify for Medicaid (and some people cannot), there are some important caveats to bear in mind. 

In order for the spouse in need of long-term care to be eligible for Medicaid, the healthy spouse is typically only able to retain a house, a car, and a modest level of assets equal to one half of the couple's assets, subject to minimum and maximum thresholds. (The maximum for 2012 is $113,640.) So putting assets in a spouse's name won't solve the problem, which becomes particularly acute if the spouse is much younger and will need assets for many more years.

Gifting assets to other loved ones also is not a viable solution if the elderly person expects to need long-term care anytime soon. If the assets are gifted five or fewer years before the individual applies for Medicaid, a penalty period applies, during which the individual is ineligible for government aid. The length of that penalty period is determined by dividing the assets that were gifted by the monthly cost of nursing home care in your state. So if you gift $100,000 to your son, and nursing care costs $5,000 per month, the penalty period would be 20 months. Moreover, the penalty period would only begin after you were already in a nursing home, had applied for Medicaid, and had spent down your assets to Medicaid-eligible levels. At that point, your only recourse would be to sell your home--which you'd otherwise be allowed to keep--or hope that one of your gift recipients would fit the bill for you until Medicaid kicked in. Needless to say, the laws are set up to deter such transfers.

The same five-year lookback provision applies to assets stashed in revocable trusts, as well--that is, trusts that can be changed after they were initially set up. It's possible to put the assets inside a revocable trust and avoid the lookback provision. You and your spouse would be entitled to any income from the trust, but the principal would pass to your heirs. Elder-law attorneys frequently set up such trusts as a means of helping families retain assets while also allowing for Medicaid eligibility, but the process can be costly. Also, you'd need to weigh whether setting aside money for your kids outweighs the added flexibility you'd have if you were to use that money for your own care. For example, you'd have greater latitude to opt for long-term care in your home or pick a facility near your spouse's or children's homes.

Given the rising cost of long-term care, as well as long-term care insurance, the problem of paying for it is likely to be with us for the foreseeable future. That argues for investigating long-term care insurance while you're young enough for it to be affordable. Alternatively, if self-insuring is part of your plan, make sure you've calculated how much you could need in a worst-case scenario, and segregate that amount from the assets you'll use to fund your in-retirement living expenses. Finally, if you expect that you may need to rely on Medicaid to help cover the cost of long-term care, but you'd also like to pass assets to your children, the asset-transfer penalties outlined above should provide a strong incentive to gift to your loved ones preemptively, well before your need for long-term care arises. I'll be writing more about these and other issues related to long-term care in the future.

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Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.