How does a care annuity work? It comes with special features to fund fees long-term

Working out the best way to fund long-term care is a fraught business, and not just because it is so expensive.

It's usually handled by adult children or other family members struggling to do their best for a vulnerable relative, who can no longer look after themselves or their own finances.

Once assets are depleted to a certain level you can receive state help for residential care, or assistance at home - and in cases of extreme ill health the NHS picks up the bill.

However, the Labour government abandoned plans for an £86,000 lifetime care spending cap, claiming the Tories had left the scheme 'unfunded'.

Instead it intends to create a National Care Service, and has created an independent commission to come up with cross-party plans for social care, but reforms are still years off.

That means families are stuck with the current funding system for the foreseeable future, with any who can afford it having to make some tough decisions at an emotional time.

These may be dictated by the health and personal circumstances of the person needing care, but the main options are paying out of cash savings, drawing down an income from investments, and buying an annuity to cover bills for the rest of someone's life.

A care annuity, also known as an immediate needs annuity, generates a guaranteed income and comes with tax benefits.

The tax advantages can make these annuities attractive enough to offset the big upfront cost when someone may not have long to live.

They are typically bought by family members who have power of attorney because the relative who needs care has lost capacity to make financial decision or deal with the purchase process.

'A care annuity can be a great option for people who have care needs and are worried about being able to pay the costs long-term,' says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.

'Purchasing a care annuity gives peace of mind that at least a portion of your care needs will be covered no matter how long you live and these can cover care that is delivered in the home environment as well as in a care home.

'The income is paid tax free as it goes direct to the care provider and it has the added benefit of removing a chunk of money from people’s estates for inheritance tax purposes.'

William Burrows, who runs The Annuity Project and is a financial adviser at Eadon & Co, says: 'The key issues with care annuities are very similar to those with pension annuities.

'The purchasers have to grapple with one of the hardest decisions in personal finance; whether to take income from capital or purchase an annuity.

'This dilemma is more acute in care because elderly people or their family have a difficult decision; arrange an annuity and facing losing money which would have been an inheritance if they die soon after purchasing the annuity or drawdown from capital thereby risking running out of money.'

Below we look at how care annuities work, what they cost and the issues to weigh up before you buy one.

The income from a care annuity is paid direct to a registered residential or at home care provider, explains Lucie Spencer of Evelyn Partners.

You therefore need to check with your chosen firm first that they will accept payment in this form, but most providers like it because it offers them more financial certainty, she says.

Spencer, who is a financial planning partner and a member of the Society of Later Life Advisers, says in her experience of sorting out care annuities for clients, businesses invariably agree to the arrangement.

The person being cared for does not have to pay income tax on the direct payments going to their care provider, and the money saved can be significant, she says.

Spencer also reiterates the point made above, about an annuity purchase reducing the size of an estate and potentially cutting or removing an inheritance tax liability.

She adds that you will have to go through a financial adviser to get a care annuity.

'Due to the annuity not being suitable for everyone the annuity providers will only provide the quotes to financial advisers who are qualified to provide the advice and not to the general public.'

Meanwhile, Spencer warns you should be prepared for intense medical vetting, because annuity providers need to assess life expectancy.

This includes reports from care home staff and a GP, and having to answer possibly rather intimate questions about your elderly parent or relative, she says.

Spencer points to this example of a medical questionnaire, to illustrate what you should expect.

Only four businesses offer care annuities: Legal & General, Aviva, Just and National Friendly.

You can't compare the rates with typical annuities which fund retirement, because they are intended to cover care costs which can be very high, according to Spencer.

They are for people who already have health difficulties and therefore lower life expectancy, which will obviously affect the quote but be specific to an individual.

Meanwhile, you will have to factor in financial adviser fees, which are discussed below.

'As these annuities are medically underwritten the costs of them can vary widely so it is difficult to put an average cost to them,' says Helen Morrissey of Hargreaves.

Just offers broad estimates of the average cost of providing an initial income of £20,000 a year at various ages, though it cautions that quotes will also depend on any product features chosen - see the table below.

'This has been based on the average health condition of a person entering a residential care home purchasing our care plan, in which conditions such as dementia, heart disease and stroke commonly feature,' it says.

Life expectancy

It is impossible to judge for certain, and it is emotionally hard to do on top of everything else.

But if someone is in seriously poor health that may make a decision to keep their savings in cash rather than buy an annuity more straightforward.

'Perhaps the biggest issue for care annuities is life expectancy,' says William Burrows of Eadon & Co

'It is difficult to calculate how an elderly person (over the age of 80) in care will live especially if they have multiple health issues.'

He adds: 'Insurance companies set the odds in their favour when pricing these annuities so can be difficult to work out if they are good value for money.'

Suitability for individual circumstances

Care annuities cost a lot of money upfront, and families usually face this at quite an emotional time, says Spencer.

She says adult children with power of attorney may be arranging care and a house sale, while suddenly dealing with a parent's money for the first time, so some prefer to postpone a decision about longer term funding.

Spencer suggests people get the opinion of the person needing care if that is possible, but also other members of the family.

On occasions when she has spoken direct to the person needing care about an annuity purchase, Spencer has found that it gives them peace of mind that fees are taken care of for the rest of their life, and that any further inheritance they still want to leave will not be entirely swallowed up by care costs.

The Government-backed website MoneyHelper offers information to help people decide if a care annuity is suitable.

It says that it might be if you’re already in a care home, about to move into one, or receiving care at home, and you want to know that you have a regular income for life.

But it might not be suitable if you don’t need to pay for care immediately, think you might only need it temporarily, might want your money back in future, or there is a good chance you would be entitled to NHS Continuing Healthcare Care funding.

Care fees

'You can get care annuities that rise every year which offers some protection from rising care costs,' says Morrissey.

'But it’s important to remember that care costs can rise quickly and these increases may start to outstrip what you get from the annuity. It's important to consider how you would cover any shortfall if this were to happen.'

Alternative options

Using cash savings and investment drawdown are the other main ways to fund long-term care, but there are different strategies.

Burrows says: When faced with such a difficult decision and taking into account the large numbers involved, it might make sense to hedge your bets for example funding part of the care fees with an annuity and the rest by drawing from capital.'

He also says that if an older person is not in a registered care setting they can still buy a ‘purchased life annuity’.

'These annuities are similar to care annuities but do not take health into account.

'A purchased life annuity at age 80 paying £50,000 per annum will cost between £440,000 and £500,000 depending on the options chosen.'

'Unlike care annuities which are all tax free there is a small amount of tax to pay depending on age.

'The cost of a care annuity will be much less than this because they take health into account. Each care annuity is individually underwritten and assessed and they are likely to cost about 30–40 per cent less.'

Capital protection

You can buy a care annuity with a 'guarantee period', which protects against the loss of all or most of your purchase money if you die shortly afterwards.

But Spencer warns you can only get capital protection on up to 75 per cent of the money, minus what has already been paid out to a care provider - plus you pay for the capital protection feature.

Financial advice

As explained above, you will need to pay an adviser to get care annuity quotes for you. Annuity providers require this because the purchase process and financial decision-making involved can get complicated.

You can look for a professional who is accredited by the Society of Later Life Advisers, and therefore should have the expertise to help you.

Spencer says if you hold power of attorney for someone who needs care then it is helpful to have an adviser, who will assist you in considering all available options for long-term funding.

In terms of cost, she says Evelyn charges a flat fee of £750 to get care annuity quotes for a client, after which an adviser will discuss with them whether to proceed or not. If they do, the total charge including the initial fee is £2,500.

Morrissey says it's really important to get financial advice before buying a care annuity, and a Solla-accredited adviser will specialise in care funding.

'Quotes will be medically underwritten so it's important to include all medical information as care needs will need to be thoroughly understood and they will look across a range of providers for the best option.

'In many cases the adviser may need to work with the person holding power of attorney for the person needing care as well as the care provider and the insurance company and this can cause complexity.'