Care Fees Financial Planning

Arthur Childs
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View from luxurious care home

You can do your own financial planning to prepare for care fees in later life.

Firstly you will need to make sure that you have sufficient retirement income to meet a large proportion of the care fees.

Secondly you will need to have built up sufficient capital to make up for the likely annual shortfall in care fees. The capital can be used to purchase a care fees annuity or to make up for the shortfall on an annual basis.

In many cases the financial planning is left to someone else to do at the point at which you are to go into a care home or need care in your home. That person will ideally have been appointed beforehand as your attorney under a Lasting Power of Attorney or they won’t be able to manage your investments or purchase a care fees annuity for you without the lengthy and expensive process of applying to the Court of Protection.

Table of contents

Calculating the shortfall in care fees

Care fees financial planning starts in the same way as any other financial planning with the need that has to be addressed. In this case what is the shortfall in care fees funding that needs to be met? This can be addressed with a simple income and expenditure table.

Estimated Annual Expenditure
Estimated Annual Income
Shortfall in Care Fees etc to be addressed

Available Assets for use in Care Fees Financial Planning

Having worked out the shortfall in care fees you next need to establish what existing assets are available which can be used to make up the shortfall. This might consist of the following:

  • Main residence – Will this be sold so that the equity in the home can be invested? Of course, if the property is still home to a spouse, partner or other relative then this will need to be ignored for the present purpose of establishing what funds are available to meet the shortfall in care fees. Rather than selling the property it might be appropriate to rent it out, particularly if, in due course other members of the family would like to own it. Depending on the circumstances equity release might provide a solution.
  • Other Property – If there is one or more other properties then these may already be providing rental income or they may be able to be sold. Property is not a particularly liquid asset in that it can take quite a while to complete on the sale of a property and the capital gains tax situation will need to be considered.
  • Cash Accounts (including Cash ISAs) – Cash is, of course, the easiest asset to deal with and the only restriction may be an account which was set up for a fixed term that has yet to complete. Cash will be the first port of call to make up for the shortfall in care fees for an initial period.
  • Stocks & Shares ISAs – If these are not needed initially then they can be left to provide capital growth either to meet the future shortfall in care fees or to provide an inheritance to the family. Where there are other investments (apart from investment bonds and venture capital trusts) then those other investments should be used before Stocks & Shares ISAs so that as much capital as possible in kept in a tax free environment.
  • Investment Bonds – If there are existing investment bonds then these can be very useful in providing additional ‘income’ on a tax deferred basis. In addition the Charging for Residential Accommodation Guidelines (CRAG) states ‘If an investment bond is written as one or more life insurance policies that contain cashing-in rights by way of options for total or partial surrender, then the value of those rights has to be disregarded as a capital asset in the financial assessment for residential accommodation.’
  • Pension Funds – Following the introduction of pension drawdown on 6 April 2015 many more pension pots have been left to produce income by drawing down amounts as and when required rather than converting the whole fund into an annuity at retirement. It is possible, therefore, that one or more of the assets is a pension pot of some description. If the pension pot is uncrystallised then part of any withdrawal (currently 25%) would be tax free and the excess subject to income tax. If the pension pot is crystallised then any withdrawal will be subject to income tax. One important aspect is that pension funds do not usually form part of a person’s estate for inheritance tax purposes. Therefore if there is likely to be inheritance tax on the estate of the person in care it is good financial planning to leave these pension funds untouched if other funds are available.
  • Venture Capital Trusts – If there are existing venture capital trusts (VCTs) then these could be providing a relatively high level of tax free income and the most suitable solution could be to leave them in place. Unlike Stocks & Shares ISAs venture capital trusts can be passed to other members of the family on death whilst retaining their tax efficient status.
  • Enterprise Investment Schemes – As with VCTs an enterprise investment scheme (EIS) could be providing a relatively high level of tax free income and the most suitable solution could be to leave them in place. Furthermore, an EIS-qualifying company should benefit from 100% relief from inheritance tax, provided the investment is held for two years and at the time of death.
  • Investments in Trust – If there are assets in trust then it is important to take legal advice. The trustees of most trusts (except bare trusts) have the authority to decide who will benefit from the trust. It might be appropriate, therefore, to avoid paying benefits to someone receiving care. On the other hand, particularly for a younger person receiving care, it might be appropriate to direct income from the trust to pay for part or all of that person’s care fees.
  • Other investments and personal possessions – Whether such items as jewelry, a wine cellar, gold bars, a stamp collection, bitcoin, art, antiques or a special car should be sold will depend on whether there was a desire to pass these on to other family members.

Using a Care Fees Annuity

The essence of an annuity is that you use a lump sum to purchase an insurance policy which will guarantee a certain level of income for the rest of your life. When used to fund a shortfall in care fees such annuities are typically called Care Fees Annuities or Care Fees Plans. They are, in effect, ‘impaired life’ annuities and can provide a level income or an increasing income.

The main requirement for qualification as a Care Fees Annuity are that at the time the annuity is taken out the person upon whose life the annuity depends is unable to live independently without assistance because of injury, sickness etc. Furthermore the income from the annuity must be paid direct to a registered care provider or a local authority by an insurance company for the provision of care for the person upon whose life the annuity depends.

When the income from the Care Fees Annuity is paid direct to a care home then it is tax free.

It is important to note that a Care Fees Annuity does not guarantee to pay the shortfall in care fees because the care home may increase them beyond the increases arranged in the plan. Furthermore they are high risk in the respect that if the person dies earlier than expected a large amount of capital would be wasted that could have gone to that person’s family. It is possible to arrange for an element of capital protection but this will add significantly to the initial cost of the annuity.

It is also possible to use a Deferred Care Fees Annuity. This is the same as a standard Care Fees Annuity except that it introduces a waiting period of 1,2,3,4 or 5 years before the income payments commence. It’s purpose is to reduce the annuity purchase price for those who can make up the care fees shortfall themselves for a period.

There can be a large difference between the insurers as to the lump sum required to fund a certain level of income so it is important to shop around or take professional advice.

Advantages of a Care Fees Annuity
  • It will pay a guaranteed income to the care provider for the rest of the person’s life to help meet the cost of their care and removes any income tax liability. However, the rules governing tax can be reviewed and may change in the future.
  • It will provide peace of mind that the care fees will be covered for the remainder of the person’s life.
  • There is no investment risk although there is a potential significant capital loss if the person dies early on .
  • The Care Fees Annuity can be set up to increase each year at a fixed level, or in line with inflation.
  • A Care fees Annuity provides a straightforward solution to the shortfall in care fees. It is simple to understand and because there is no investment element, there are no on-going costs and no need for regular reviews.
  • A capital protection option can be used to protect some of the investment amount and have this paid back to the estate should the person die early on.
  • Any unused capital not required to fund the Care Fees Annuity can be invested for the eventual benefit of the person’s family.
Potential disadvantages of a Care Fees Annuity
  • The income paid by a Care Fees Annuity will affect any means-tested state benefits that the person is entitled to. Such benefits are likely to be reduced or could even be removed in their entirety.
  • Unless some form of capital protection is added to the Care Fees Annuity the early death of the person will mean that the amount received in income payments will be significantly less than the amount invested.
  • Any capital protection amount paid after the death of the person will be included in their estate for Inheritance Tax purposes.
  • Unless the Care Fees Annuity is set up with escalation of benefits the income from will not keep pace with the rise in the cost of care. Even if escalation of benefits is included there is no guarantee that it will match the increasing cost of care.
  • Under a Deferred Care Fees Annuity the person will need to pay the care fees themselves until the end of the deferred period. It is important to make sure that sufficient funds are available to do so. An increase in costs could mean that the person’s money runs out sooner than expected.
  • If circumstances change, the person may require a higher level of income payments and will need to find funds for this from elsewhere.
  • Once the Care Fees Annuity has commenced and the 30-day cancellation period has passed, the annuity cannot be changed and there is no surrender value at any time.

Using Investments for Care Fees Financial Planning

One of the areas that you will need to look at when considering care fees funding is your current portfolio of investments.  Earlier in life your investments might have been arranged to provide a good level of capital growth with possibly some income.  Once a high level of care fees require to be covered the emphasis of your investment portfolio is likely to need to be moved to producing maximum income only. 

Many investments can be switched from a growth mode to an income mode quite easily, whilst others will need to be surrendered and transferred to something quite different.

When using investments to make up the shortfall in care fees it is usually best to keep sufficient monies in cash for a full year’s shortfall requirements. This avoids having to sell units or shares each month when markets might be performing poorly. Money can then be transferred at an appropriate time to top up the cash reserves, hopefully at a time when markets are rising or at least not falling.

It is important to be aware of the tax implications of each investment so as not to pay tax unnecessarily on that income. For example income from Stocks & Shares ISAs and Venture Capital Trusts (VCTs) is tax free. Annual withdrawals of up to 5% of the initial investment on a cumulative basis can be taken from an investment bond with tax deferred until the final surrender of the bond. Regular withdrawals of capital from unit trusts and investment trusts within the annual exempt amount for capital gains tax will effectively provide a further source of further tax free ‘income’.

When planning it is important to have an idea of the average life expectancy of people of the age reached by the person needing care. The average life expectancy in a care home is no more than a few years although someone mainly suffering from dementia and otherwise healthy could live for a decade or more in a care home.

Advantages of using investments
  • If the person needing care has sufficient capital then the simplest way to provide for the shortfall in care fees is to take this from the capital which should be invested in the most appropriate manner.
  • Using investments to fund a shortfall in care fees means that there is no loss of capital for the family through the early death of the person receiving care.
  • It is easy to adjust the level of income/withdrawals from the investments to match changes in the shortfall in care fees.
Disadvantages of using investments
  • The investments may prove insufficient to fund the shortfall in care fees if the person in care lives longer than expected. This is can be particularly the situation where the person is in care mainly because of dementia but is otherwise healthy.
  • The person in care may be depressed to think that the longer they live the less inheritance they can pass to their children and grandchildren.
  • Particularly if the total amount invested is thought to be low in relation to the potential long-term shortfall then it could be necessary to take increased investment risk so as not to run out of money. This could be disastrous in a significant market downturn.
  • The investments will need to be managed and this will involve time and cost administering the investments and completing tax returns etc.

Using an Equity Release Plan for Care Fees Financial Planning

Equity release plans are technically known as Lifetime Mortgages.

A common expectation for many people is that their home will have to be sold in order to pay for any care that is required.  Being forced into selling your home in order to meet care costs could be a source of great distress, especially when you are already suffering some loss of independence and control over your life.

You may also feel that you have nothing of value to hand on to your children after a lifetime of hard work.  It also restricts your options and removes the choice of receiving care in your own home, which most people prefer.

Where the capital that you require is much less than the value of your home some form of equity release plan may be appropriate.  These are now generally known as lifetime mortgages and the capital released from your home can be used to purchase an annuity or just provide additional capital to pay the care fees.

A number of providers of lifetime mortgages have combined together to set up Safe Home Income Plans (SHIPS).  Where schemes are covered by Safe Home Income Plans the debt can never become larger than the value of your home.

The financial services regulator, the Financial Conduct Authority (FCA) considers such arrangements to be high risk and that it is essential that your solicitor and where, possible, other family members are involved in, or at least aware of, this decision.  

Advantages of using a Lifetime Mortgage
  • It enables you to raise capital which could be used to purchase a Care fees Annuity without selling your home.
  • The interest rate you pay on your initial advance will be fixed at the time you take out your mortgage, and is guaranteed not to change. The only time the interest rate would change is if you received a reduction to the roll-up interest rate due to paying some or all of your monthly interest amount and you stop making any monthly payments. If you have a cash facility and take an additional advance, the interest rate for that will be set at that time and may be higher or lower than the rate you are paying on your initial advance.
  • The total amount you owe, including any interest, will usually be repaid from the money made from selling the property when you die.
Disadvantages of using a Lifetime Mortgage
  • Any interest that is not being paid monthly will build up on a compound basis, which means interest will be charged on the amount of your mortgage as well as the interest that has built up in previous months.
  • A lifetime mortgage is a lifelong commitment and is designed to be repaid when you (or both of you if you are borrowing jointly) have died. If you repay your lifetime mortgage early, you may have to pay a substantial early repayment charge.
  • Lifetime mortgages aren’t right for everyone and may affect your entitlement to state benefits.
  • Lifetime mortgages will reduce the value of your estate.
  • Lifetime mortgages are not a suitable product for those looking to raise capital to invest.

 

Important

This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.

Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe My interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.

If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.