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Long-Term Care Insurance

Thinking of Paying for Long-Term Care from Your IRA? Think Again.

Chances are a big portion of your retirement savings are in pretax accounts like a 401(k) or IRA. If you need to tap those accounts for costly care, you must realize that every dollar is taxable. And you might be shocked at the tax rates that come with withdrawals large enough to foot the bill.

For the first time ever, the Long-Term Care (LTC) generation meets the 401(k) generation. This is, unfortunately, giving a lot of people false confidence that they can pay for their future care someday through their retirement savings, only to eventually find the rude awakening from a tax perspective that awaits them.

However, there is something else that is a new major consideration for today’s retiree — LTC planning. Not to get too hyperbolic here, but we are just now, for the first-time, planning on a concept where we stop working and live 30 more years. Please take a moment to truly let that sink in …

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Medical advancements have been staggering, and it’s a beautiful thing as far as how long we are all living. This, of course, means it’s increasingly likely we will live into our 80s and 90s, and thus need ongoing comprehensive skilled care in one way or another. That cost of care goes so far beyond the concept of “sticker shock” to today’s retirees. They literally aren’t comprehending it!

The first thing to do is get educated on the topic. You need to understand:

  1. The major difference between Medicare providing basic health insurance, and LTC costs that come out of your pocket.
  2. The different options you have for your care, and where you might need this care.
  3. The expected costs of the various forms of care, and what they’ll look like when you might need them.

An Issue for Savers in the Middle

Once you have a general understanding, you can now look at how this will (or will not) work with your own retirement plan. If you, unfortunately, have not saved any money for retirement, then the cost of care for you will most likely be provided via Medicaid (which is currently very underfunded, with not the best facilities in the world even if you did get in). If you’ve saved up several million dollars in after-tax, non-retirement accounts, then the earnings alone from your money mean you can self-insure and will be fine if this happens to you someday.

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I’m speaking to the retiree that has between a few hundred thousand and a few million dollars, some or the bulk of which in pretax retirement accounts, such as traditional 401(k)s and IRAs. This means I’m speaking to a massive amount of you heading into retirement. So, let’s paint a picture here …

The “it will never happen to me” mentality can plague many people, and it does not fare well when a LTC event arises as it can drain your retirement savings. On average nearly 70% of 65-year-olds will eventually need some form of LTC, according to the U.S. Department of Health & Human Services (HHS). HHS also estimates that 20% will need LTC for more than five years. According to a 2018 Genworth Cost of Care Survey, the national median monthly costs for adult day health care, assisted living facility and private room care are $1,560, $4,000 and $8,365, respectively. But remember, inflation can impact these median monthly costs, as well as the location in which you retire in.

Possible Tax Consequences

Tax planning in retirement is something we focus on very much, because it’s the first time in a person’s life they choose where they get their income from. Depending on where they pull money from in retirement, it can mean drastic differences in the taxes they pay. Every dollar you pull out of your pretax retirement accounts is taxable income, and the more you pull out in any one year, the greater chance that you vault yourself into higher and higher tax rates.

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Can you imagine the horrifying tax result of needing to pull those kinds of dollars out in any single year to cover the exorbitant LTC expenses? You can end up paying double or triple the tax rates on that 401(k) money because of this — or another way of saying it, is that you can drain down your account twice or three times as fast!

If you think that is the worst of it, think again. Our tax rates are at historic lows currently, with our national debt at historic highs. While nobody knows what tax rates will be in the future, we all must be prudent enough to consider the possibility of them being higher — and even much higher than they are today.

The thought of this entire generation not realizing this until it’s too late, and then having a LTC event happen someday, makes me shudder. Once people see what kind of taxes they’ll end up paying, my thought is they will abandon the strategy and desperately try other things.

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This could cause many people to sell their homes in order to tap into after tax money to pay for the care. Obviously, this is devastating to many people who worked long and hard for their homes and don’t want to be forced out, as well as not be able to pass those homes down to their kids and loved ones. Others may not have that option, and family members will be forced to take them in. This can cause a tremendous amount of emotional, physical, and psychological damage to the caregivers who aren’t prepared to take on this task.

What Should You Do to Prepare Now?

If you are still working and saving, I always recommend diversifying your money into different tax buckets. Don’t just save all of your money in your pretax 401(k), but save in Roth accounts and non-retirement accounts to build up after-tax resources in retirement. If you are already retired, you can look at doing Roth conversions. Please consult your financial and tax advisers when looking at these strategies.

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Another option is to purchase LTC insurance. Please note that LTC insurance is not right for everyone, and even if it is a good idea for your situation, you need to be very careful about what amount, type and specific product you buy. With that being said, it is absolutely something today’s retiree needs to look into, because buying LTC insurance can help accomplish two major things:

  1. It forces someone to acknowledge the future likelihood of these risks, and to put a plan in place to account for it someday.
  2. The benefits get paid out tax-free!

In summary, thinking of your retirement accounts as a LTC strategy can someday leave you with what my clients have summarized as three main options, typically:

  1. You pay a shocking amount in taxes.
  2. You sell other assets you wish you didn’t have to.
  3. You could end up becoming a burden on your family.

The moral of the story is to not take the ostrich approach and bury your head in the sand when it comes to the topic of LTC. Because you never know, it might happen to you or a loved one. This is very real and can be devastating financially when you don’t have a plan and strategy in place for it.

Investment Advisory Services offered through Epstein and White Financial LLC, a Registered Investment Adviser.

CA Insurance Number: OH26322

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About the Author

Bradley White, CFP™, IAR

Vice President, Epstein and White Retirement Income Solutions

Bradley White is vice president of Epstein and White. He's a Certified Financial Planner™ and has a bachelor's degree in finance from San Diego State University. He's an Investment Advisor Representative (IAR) with his Series 66 license and an insurance professional.

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