In my first two posts of this three part series I examined a few scenarios using our Financial Calculator, available for inclusion on CCRCs’ websites, to gain an understanding of when it makes sense to consider a refundable entry fee contract offered by a retirement community as opposed to the standard, non-refundable contract. Although pricing schemes may vary dramatically from one CCRC to another, I arrived at the general conclusion for my example that a resident or couple would need to earn at least 5-7% on their money and at least one spouse would need to remain in the community for approximately 16 years or longer before the standard, non-refundable contract would prove to be the optimal choice. Achieving this rate of return for a retirement portfolio in today’s environment is a tall order.
Since the time of my last post I ran some additional scenarios using pricing details for some other CCRCs. Overall these scenarios also revealed that at least one spouse would need to remain in the community for more than 15 years but the required rate of return wasn’t quite as high- more in the 3-4% range; perhaps still a tall order in today’s environment, particularly if the money is in a savings or money market account.
Yet, there was one other aspect I wanted to consider and I was curious to see how it might impact my results. I wanted to see if owning or purchasing life insurance would impact the results. With rare exception I found that if the resident(s) already owns life insurance it really does not impact the results because, whether the residents choose the refundable contract or the standard contract, the life insurance proceeds simply add dollars to the end results.
But then I had another thought, what if the residents take the difference in cost between the entry fee for the standard contract and the refundable contract- $139,000 in my example- and use this money to purchase a second-to-die life insurance policy for an amount of coverage amounting to more than they would ultimately have receive from the refundable option. After all, prospective CCRC residents are generally quite healthy for their age so qualifying for the insurance shouldn’t be too much of an obstacle. Plus, there are a couple of reasons why life insurance might be preferred over the refund option. (Note: estate tax implications should be taken into consideration before any such recommendation.)
First, the life insurance is provided by a large, highly-rated life insurance company and backed by the state guarantee association. The refundable contract, by comparison, is backed solely by the operations and financial management of the retirement community, although some CCRCs may place refundable entry fees in an escrow account.
Second, most CCRCs have stipulations that dictate when a resident will receive the refund. Many people do not realize that quite often CCRCs will require the residential unit to be re-occupied by a new resident before the refund is paid. Life insurance, on the other hand, is paid directly to the beneficiary within a week or two after a claim is filed. I felt for sure that I had uncovered a new and innovative use for life insurance that no one had ever considered!
However, my results revealed a couple of problems with this approach. It was more difficult to than I anticipated it would be to buy the necessary amount of coverage using only the difference between the two entry fees. I felt sure that my imaginary couple, even at ages 73 and 72, could leverage $139,000 (the difference in entry fees between the standard contract and the 90% refundable contract) to buy life insurance exceeding $288,000 (the refundable amount under the 90% contract). Yet, this was not the case. Using my resources I requested a quote for a guaranteed policy for a healthy couple, ages 73 and 72, and spreading $139,000 over twenty years for a premium of $6,950 per year. The quote produced an amount of coverage quite a bit less than $288,000. (Of course, there may be some other insurance companies out there that could offer a more competitive policy, which could make this approach more feasible.)
But even if I could get the numbers to work out on the life insurance there isone other problem I ran into. Obviously, the life insurance would only pay out at the death of the second spouse. So what happens if the residents were to leave the community before death? This is a rare scenario but it certainly could happen for a number of reasons. In this case the residents end up with significantly less money than they would if they opted for the refund, particularly if they left the community sometime after two years but before death.
Let’s examine why this is the case. If the couple chooses the standard, non-refundable contract and purchases life insurance then they will retain $139,000 in their own savings (less the annual premiums of $6,950 per year) instead of turning it over to the retirement community. Plus, in almost every case, even the standard, non-refundable contract will refund some portion of the entrance fee if the residents move out within the first few years. For example, the non-refundable contract for the specific CCRC I looked at in my example reads, “The resident or resident’s estate will receive a refund of the entrance fee previously paid, without interest, less 2% for each month of residency or portion thereof for up to 50 months.” So, let’s suppose the residents decide in two years they are not happy and want to move out of the community. Even under the standard contract they would be refunded $94,000 in this instance. Remember too, they still have $125,100 in savings ($139,000 minus two years of life insurance premium). This is a total of $219,000 but still less than the $288,000 they would receive under the refundable contract. And if the residents move out in the third or fourth year, or beyond, they would end up with even less, while the refundable contract would still pay $288,000.
In summary, there may be situations where prospective resident could, indeed, make the life insurance solution work as an alternative to the refundable contract. As I mentioned, CCRCs price contracts differently and there may be policies out there that are more competitive than the one I used for my example. But, going off of my example alone, the life insurance approach as an alternative to a refund option did not appear to be the answer.
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