In last week’s post I was talking about the tax deductibility of long term care expenses. Some medical expenses can be deducted from gross income before calculating any tax due and owing. Long term care expenses can be deductible if within the definition set out by the IRS. (See last week’s post)
Let’s now look at how this can positively impact a senior who is spending $100,000 to $150,000 per year or more for long term care. In most cases that senior will not have enough income to pay the entire cost. He or she will need to spend some of any accumulated nest egg. That’s where the opportunity lies.
Suppose that senior has a retirement account, a nonretirement account invested in stocks and a savings account. One may be better to liquidate than another because of the income tax implications. Retirement accounts are tax deferred accounts. Most or all of the growth in these accounts has never been taxed. The owner pays the tax when money is withdrawn from the retirement account. The stock held in the nonretirement account may have appreciated if the stock’s price is higher than when the owner purchased the stock. This capital gains in “unrealized”, meaning no tax is paid on the gain until the stock is sold. Finally, the savings account earns interest, but the owner pays the tax on that interest each year.
If, for example, the owner has a six figure long term care expense, this will result in a potentially large medical deduction. Here’s the way it works. If a taxpayer’s total medical expenses exceed 10% of adjusted gross income (AGI) the amount that exceeds the 10% threshold can be deducted from AGI. Most people that need long term care are retired and have less income than when they were employed. A lower income number means the 10% threshold is easier to meet.
Knowing this then, wouldn’t it make sense to liquidate an asset that will cause a tax if we have enough of a deduction to absorb some or many cases all of the tax that would otherwise be owed? It would. This leads to looking to the retirement account and the stock account first before turning to the savings account when deciding what to liquidate. It’s what I mean when I talk about stretching out assets.
As we know, a retirement account with $100,000 is worth less than a nonretirement account with the same amount. Funds withdrawn from the retirement account owe federal and state income tax of approximately 25 to 40%. If, on the other hand, consideration is given to the tax deductibility of long term care, that tax can be reduced or entirely eliminated. As I always say with respect to managing the cost of long term care, timing is everything. This is a perfect example.