There is a stark reality for nearly 70% of your clients. As they grow older, they will require some form of Long Term Care. While the length of care needed will vary based on their circumstances, the one constant they can count on is the prohibitive cost associated with nursing homes, hospital stays, treatments, and support. Clients who have saved their entire lives, invested in life insurance, and planned to leave a financial legacy for their loved ones risk losing everything they have worked for in order to cover LTC expenses. This is not a fate that we would ever desire for our clients. Planning for the possibility of LTC events has become a necessity. LTC insurance, however, has been associated with high and fluctuating premiums and potentially wasted investment. While hybrid life insurance vehicles offer a way through the LTC planning quagmire, there is another approach that may better fit the bill for your clients: the ability to turn traditional IRA’s, 401(k)s, and 403(b)s into a tax-deferred LTC expense backstop.
The Backstory: Common LTC Expenses and Solutions
As we have covered in previous articles, the expenses associated with LTC are staggering. The monthly cost for a nursing home or aged living facility in the United States can reach $8,000. Assisted living and at-home care are similarly exorbitant. For the consumer, the problem with LTC costs is essentially one of planning. Without knowing for certain that they will need LTC, setting aside such large sums can seem frivolous. At the same time, thinking about a bleak future involving LTC is anathema to their dream of retirement and the fulfillment of their life of work. This is why your advice and guidance is key to helping them protect their financial future without taking away from their living capital.
There are 3 ways to deal with the possibility of LTC expenses:
- Pay out-of-pocket
- Obtain LTC insurance (either traditional or hybrid)
- Prepare your IRA, 401(k), or 401(b) to cover your expenses
Let’s take a quick look at each of these.
Planning to pay for possible LTC expenses out of pocket is perhaps the worst of these options. It is difficult to save for the unknown and the very nature of LTC is flux. Some people require care for a year or two while others require care for a decade. To tie up living capital in this way means that you are not able to enjoy the fruits of your labors out of caution. The money that you are saving for LTC has already been taxed, so there’s no benefit on that front, either.
Obtain LTC Insurance or Hybrid Life/LTC insurance
These are both valid ways to hedge against the money pit of LTC expenses. They both guarantee that you will be financially capable of covering most or all of your expenses should the need arise.
With traditional LTC insurance, you are not accruing cash value and should you never require LTC, you will have spent the money invested towards it.
With a hybrid plan, you will not risk wasting your investment and you will also gain the death benefit to pass on to your loved ones. Here is some more information on the differences between these two.
Prepare your IRA, 401(k), or 401(b) to cover your expenses
This option answers some of the problems associated with traditional LTC insurance as far as costs are concerned and may be a better fit for some clients than a hybrid policy. It definitely solves all of the issues associated with paying out of pocket.
In a nutshell, your client can use a qualified IRA, 401(k), or 401(b) to pay for LTC expenses. This can all be done thanks to IRS Publication 502. Publication 502 includes LTC options as part of its “medical care” exemptions. This allows the consumer to deduct anything above 10% of their adjusted gross income. By using an IRA to pay for the LTC policy, the consumer is allowed to take pre-tax dollars associated with the IRA and utilize them tax-free for LTC expenses.
Here’s an example:
Your client, Edward, is retired. They receive a social security check for $2,000 a month or $24,000 per year. Edward is going to require LTC expenses of $5,000 per month or $60,000 per year. If Edward converts the money in his IRA to pay for his LTC expenses that will mean that his adjusted gross income (social security plus the $60,000 he pulls from the IRA) will be $84,000. Since the money is going towards his LTC expenses he will be able to deduct anything above 10% of his adjusted gross income. The result? Of the $84,000, Edward will be taxed on only $8,400 of that money leaving $75,600 as a tax-free expense towards LTC. Not bad at all!
What Does This Mean and Why Is It Better?
Using money from an IRA to fund LTC expenses allows your client to prepare for the worst while leaving their taxable investments untouched for their loved ones. This means that they were able to save on taxes in order to fund their LTC needs while leaving investments that have already been taxed behind to their children and spouse. The legacy benefit of this should not be understated.
Additionally, they are leveraging the tax code to better spend their pre-tax dollars on something truly invaluable should the need arise. The hard truth is that everyone who plans on getting older (which should be all of us) needs to prepare for the possibility of assisted living, illnesses, cognitive decline, and all the other unknowns that lie in wait as we age. Flexibility is the key to a healthy financial and insurance portfolio. Leveraging an IRA to cover what could be the greatest expense of our lives is another arrow in the quiver of preparedness and one you should definitely research on behalf of your clients.