Thinking about how you will cope late in life is not something that particularly appeals to most of us. But stories about how the elderly are treated – and the massive costs associated with care homes – can act as something of a wake-up call.

In a recently issued Green Paper, the government is inviting people to think about how care of the elderly should be funded in the future. Options include a partnership between individuals and the state, as well as some forms of pre-funding – which could involve people being forced to pay as much as £20,000 at retirement.

Interestingly, the government outlawed one of the most innovative solutions in the mid 1990s, when one insurance company was offering annuities that increased automatically late in life, when nursing care became required, without any additional investment by the individual – just evidence of incapacity. This flexibility was considered a breach of the pension rules.

This issue will not go away
The problem is that with people living much longer – and generally in better health – it is increasingly likely that more of us will reach the age where personal care becomes a necessity.

How long the need for care will last depends on the individual, but experience shows that six months (at a cost of £700 per week) is by no means unusual and many people can be in a nursing home for much longer.

This raises the issue that, if the state cannot really afford to provide any decent level of care for us when we grow older, what can we do for ourselves?

Possible solutions
At present, apart from using the (currently) tax free pension commencement lump sum – which can be up to a quarter of your accumulated fund – to buy a long term care plan when you retire, pension rules do not allow much flexibility. What discretion is given to pension plan holders over their retirement income is effectively withdrawn at age 75 when new rules impose tight limits on how much can be drawn from a pension scheme, if an annuity has not been purchased.

This means that, for most people, planning for long term care is likely to involve investments that fall outside the pension regime.

Alternative route
Fortunately, Individual Savings Accounts (ISAs) offer similar benefits to pensions in terms of tax treatment. Although there is no tax relief on contributions paid in, all growth and income within the fund (except, thanks to Gordon Brown, when Chancellor, the 10% withholding tax on dividends from UK companies) is free of UK taxes and the money can be taken out totally free of tax.

This means that you are free to use the money as you wish, including to pay for long term care. And if you decide (at the time) to purchase an annuity payable directly to a care home, current rules make the payments ‘tax free’ – normally, at least some tax is deducted from most annuities.

There are other ways of achieving the same end, so taking professional advice before making any decision relating to your personal finances is essential. As ever the value of investments is not guaranteed and will fluctuate; you may get back less than you put in.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.