- Monevator - https://monevator.com -

Paying for social care using your investments

Posted By Team Monevator On In Spending,Deaccumulation | 8 Comments

This is part six of a series on planning and paying for later life social care costs.

We’ve previously:

Today we’ll look at how to self-fund care from your assets.

We’ve previously covered what a Local Authority counts in its means test. This test determines how much you personally have to pay.

This time we pass the baton to professional paraplanner – and Monevator contributor – Planalyst.

Assuming you’ve been deemed a self-funder, how might your own assets pay for your social care?

Take it away Planalyst!

Personal experience

Any social care I might need is likely many decades away. However my grandparents required care later in later life. I know my parents could too.

I work as a paraplanner for a financial advice firm. This role includes advising clients on how to fund social care at the point of need.

We should all know about the care system. You may stay fit as a fiddle by the end. But what about your parents, or a partner? What if you want to pay top-up fees [6] to get them into a nicer or better-located care home? Life happens.

Today we’ll look at how to pay for social care with products that have some specific application to this purpose.

We’ll only mention in passing investments like equities and bonds. Most Monevator readers are plenty familiar with those.

Immediate Needs Annuity

Typically the go-to product for anyone needing care, an Immediate Needs Annuity is the only financial product designed to cover care costs – at home or in a care home – currently available.

You buy an Immediate Needs Annuity with cash outside of a pension. That’s as opposed to from a pension pot, like with a typical annuity.

If paid directly to your registered care provider, the income from an Immediate Needs Annuity is tax-free. That’s the big advantage.

If instead it’s paid directly to you, then only part of the income is tax-free. That’s because a proportion counts as a return of capital.

Show me the money

For a one-off cost you get:

You can also choose a deferred care plan. This is essentially an Immediate Needs Annuity, with all the above features, only the income payments start one to five years later. This lowers the upfront cost. But you’d have to self-fund your care in the meantime.

Taking the capital protection option enables you to buy the annuity but still potentially bequeath some of the funds to your heirs (terms and conditions apply!). The extra cost might make it less attractive if you’re set on leaving a large legacy.

You can only purchase an Immediate Needs Annuity on a single-life basis. That’s different to pension annuities, which offer a joint-life basis to include a named spouse or dependant to receive your income (or a portion of it) on your death.

How to get an Immediate Needs Annuity

Anyone can put up the cash for the Immediate Needs Annuity purchase. So a relative could help to fund your annuity, if needed, for example. The tax treatment to the income remains the same, because it is still based on your life.

Immediate Needs Annuity income payments typically break even against the purchase price at around five years at current rates.

Unfortunately, ever-rising care fees have made providing these annuities less attractive to insurers. As a consequence only four providers remain in the market.

Covid has affected Immediate Needs Annuities. Today’s products may offer you capital protection for free. Such protection returns your capital purchase amount, less any income already paid, if you die from Covid within the first 6-12 months. Check the specifics with the insurer. This protection probably won’t stay available for long.

Capital investments: equities and bonds

Don’t fancy your chances of living long enough to get value for your money from an annuity? Then you’ll need to self-fund from your accumulated capital and income streams.

Check out the average life expectancy data for people in care in our previous article [7] for more.

You might decide to self-fund simply by drawing directly from your investments. But you must be sure your capital withdrawals from your ISAs and other investments will last. That leads us back to the Sustainable Withdrawal Rate (SWR) that The Accumulator covered last time.

You need to think about how much risk to take with your underlying investments. Paying for social care is a short-term objective. You don’t want sudden market declines [8] to eat into your funds just when you need to turn them into cash.

Investment bonds

This type of investment bond is bought from a life insurance company. They are not the standard corporate or government bonds we usually cover on Monevator.

Single premium investment bonds with an element of life assurance can be a good option [9] to pay for social care.

That’s because the value of investment bonds can be disregarded from your capital total for the purposes of the means test.

You must purchase investment bonds when still healthy to benefit from this feature.

If you invest in them when you need care, your Local Authority is likely to count your investment bonds as capital under the ‘deprivation of assets’ rules. (We covered deprivation of assets in part two of the series.)

These rules mean your investment bonds would count as capital even if you can’t access them – because they were gifted or placed in a Trust.

(Note that your local authority will count withdrawals from an investment bond as ‘income’ in the means test. That’s confusing because such withdrawals are normally classified as ‘capital’ by HMRC.)

Tax and investment bonds

Withdrawals from investment bonds can take two forms:

New jargon alert! Encashment just means to exchange a cheque or a financial product such as a bond for money.

The return of the originally invested capital is tax-deferred. It is included in a ‘chargeable gains’ tax calculation when the bond is partly or fully encashed. At this point the amount previously withdrawn could incur income tax.

A complex calculation is deployed to work out if an encashment of the bond has made a chargeable gain. There are lots of factors to consider.

Ultimately you’re liable to pay income tax on any chargeable gains. This tax is levied via standard self-assessment. The chargeable gain counts as savings income for your income tax calculation.

There’s also 20% deemed corporation tax already paid in an onshore bond (not offshore). That means there’s effectively a 20% tax credit:

Exotic locales

Not having taxes paid within the funds in an offshore bond means you could see higher growth compared to an onshore bond. The tax-free growth rolls up and compounds over time.

However depending on where in the world the investment is held, you could face non-reclaimable withholding taxes [10] instead. Offshore bonds are usually more expensive than onshore, too.

Bonds can be placed into various kinds of trusts. Trusts can be structured so that the person needing care could still have access to the original capital withdrawals, but a beneficiary would receive a lump sum on death. Potentially outside the estate.

Professional financial and legal advice [11] is needed. If you’re interested you must do it early in any estate planning process. And it might not be right for your circumstances.

Pension assets

Unless you’ve no other means of self-funding, starting a pension annuity or drawing down income from a pension isn’t the first port of call for funding care fees.

That’s mostly because pension and annuity income is taxable (over and above any tax-free cash). Whereas when left alone your pension investments roll-up tax-free.

Someone paying for social care is usually acutely aware of their mortality. Estate planning therefore often influences how they pay for social care. And a pension doesn’t incur inheritance tax, because it’s not included in your estate.

Wondering how to calculate your potential pension annuity annual income level? The Accumulator did that in a previous post. He used the Money Helper [12] comparison tool.

Pix-and-mix

You can combine the different funding options. For instance you could purchase a small immediate need or pension annuity income. This provides you with a guaranteed base, alongside any existing secure incomes in retirement like the state pension or other non-means-tested State benefits, or even a defined benefit pension income.

Residual savings and/or personal pensions could cover the balance.

This approach could avoid a high withdrawal rate on your invested assets. It’d also mean not spending so much on an annuity. That could leave more of your estate intact.

Your family home

Typically your largest asset, equity in your home may be required to self-fund your care.

It’s possible to keep your home in the family. You can do this by outright gifting it or placing it in a trust. Such a move must be part of genuine estate planning. Do it well in advance of any need for social care to avoid falling foul of the deprivation of assets rules.

Alternatively, you could downsize to release some equity. You’d then still have a property to pass on. Downsizing works well if you need a place to live whilst receiving care at home. You could buy a home that’s easier to maintain or is more accessible. This could reduce the level of care you need.

If you’re going into a care home, you could sell your property to use the cash to cover your care fees, and invest the excess. That excess could ultimately be left to your family.

Letting out your home as an extra source of income is another option. For many needing care it will be less attractive. You’d have all the cost and hassle of being a Buy to Let [13] mogul.

The second post [14] in this series explained how a family home is disregarded from the local authority’s financial assessment, provided certain family members or your live-in carer lives there.

There’s also a 12-week disregard if no one was left living there when you went into care. During this period, your home would not be included in the assessment. After that your property value will be considered as capital in the means test.

Equity release and deferred payment

We previously covered [14] Deferred Payment Agreements with a local authority. Such an offer is only available when you go into a care home.

The commercial equivalent is equity release. It’s broadly the same idea. You again release capital from your home. But with equity release you’re paid a lump sum upfront or multiple sums over time.

You might enter into an equity release arrangement before needing care to meet other spending needs. Note that if you’ve already taken out equity release against your home, you’re unlikely to be eligible for a Deferred Payment Agreement.

Equity release comes in various flavours, such as Lifetime Mortgage or Home Reversion. Which reviewed the details [15]. Compared to a Lifetime Mortgage, a Home Reversion plan typically gives you less than the share of your property being given up and repayments are more expensive.

Different strokes

There is one notable difference between the local authority and commercial lenders. A commercial lender who is a member of the Equity Release Council agrees that:

The first two principles wouldn’t apply to a Deferred Payment Agreement. You would already be in a care home. For that reason they may also not be relevant to your equity release deal.

The local authority puts an equity limit on the property charge – up to 70% of its value.

If you hit this level of care funding, the local authority stops paying for your care under the agreement. You’re then back to a financial assessment to see if you remain a self-funder.

What about interest?

Local authorities can choose whether to charge interest on the Deferred Payment Agreement. If they do1 [16], then interest is linked to the market gilt rate plus 0.15%.

This rate is published for local authorities in the Office for Budget Responsibility’s Economic and Fiscal Outlook every six months.

In October 2021, the weighted average interest rate on conventional gilts was 0.40%. It is forecast to be around 1% for the next seven tax years.

In contrast, equity release always incurs interest on the loan. Typically the rate is fixed, though some lenders offer variable rates. The average rate recently was 4.26%. That’s according to the Autumn Market Report 2021 from the Equity Release Council [17].

With both local authority and equity release you’ll probably lose your home to repay the debt. You may sell during your lifetime to reduce the interest you owe, or on your death. Hence your house is not going to go to the kids.

As with trusts, you should get professional financial and even legal advice.

Free support

Even self-funders should explore potential free money options, including:

We cover these free social care [18] options in the final post in the series.

Bonus appendices

Discontinued products

You might hear about a couple of products that are no longer available:

You may have elderly relatives who use/d them.

These products were very tax-efficient. Most of the payments are typically tax-free, whether paid to the person in care or directly to the care home. (The bond’s tax position is a little more complicated. It depends on how the funds are withdrawn and whether onshore or offshore.)

This income still counts as part of the means test.

Unfortunately these products disappeared due to rising cost of providing care [7]. They became less profitable for issuers even as the level of care they covered shrunk. So they’re no longer available.

Social care funding – the diagram

This flowchart simplifies the complexities of the social care system:

A social care flow chart that shows the various options, decision points and thresholds along the journey. [19]
  1. In England and Wales. [↩ [24]]