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.
By Bradley
White, CFP™, IAR | Epstein and White Retirement Income Solutions March
19, 2019
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 …
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.
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.
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.
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.
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.
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