IRAs, or any retirement accounts really, have always been a problem when it comes to long term care. They are a great vehicle for accumulating wealth. You can put away savings in an account which will earn interest on a tax deferred basis. No income tax is paid on the growth until you start taking money out.
In some cases you can put pretax dollars from your earnings into the account, meaning you don’t have to pay income taxes on that portion (again until you take the money out). As most people know, the government requires you to start drawing money out of the retirement account after you have turned age 70 and ½, according to required minimum distribution rules.
Since Congress authorized these accounts in the 1970’s the financial investment community has recognized the opportunity they have created and has spent a lot of time and expense encouraging Americans to open and fund them. The benefits are well documented but not the downside. “What might those be,” you ask?
While the government excuses income tax on the growth in these accounts, it doesn’t excuse the tax forever. As I stated, you must start withdrawing money after you reach age 70.5. But, what if you wanted or needed to withdraw the funds to pay a huge expense, one that could last for years, like long term care. What if you really didn’t want to withdraw those funds to pay that expense but would rather find another way to pay for care?
There a generally 3 ways to pay for care. One way is to use long term care insurance, a second way is using your own money or self-insuring and the third way is government benefits. As I have written about previously, for a variety of reasons many people have decided not to buy long term care insurance or have waited too long and now their health prevents them from getting it.
Government benefit programs that help pay for long term care – via Medicaid or the Veterans Administration – are needs based. In order to qualify you must be under a certain asset limitation and that’s where the retirement account becomes a problem – an albatross.
The need for long term care could last for years. When we talk about legal planning strategies, often they involve what we call 5 year trust planning. Place assets into a trust, manage the need for care for a minimum of 5 years and if care is needed we can look to tap into government benefits along the way. If 24/7 care is needed after 5 years, then Medicaid could be the source without needing to spend all your savings.
The problem with IRAs, however, is that if we must move that money to protect it, the client will have to pay a huge tax bill, approximately 40% of the value of the account. The client must do that without knowing what the future holds. If he dies without ever needing long term care, or needing it only for a short time then the decision, in hindsight, will have been the wrong one.
Next week I’ll share with you an example of what I’m talking about.