Long-Term IRA Planning for Long-Term Care

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Money saved and invested in IRAs and qualified plans can grow tax-deferred to generate income later in life. While retirees would like to enjoy the pursuits that make their hearts content, they must also expend money on physical maintenance. Besides unfortunate events and extreme longevity, healthcare is the third significant unsystematic retirement risk. It is “unsystematic” because occurrences are random and vary among individuals. This article focuses on a specific type of healthcare-related risk: Long-term Care (LTC) or extended care (i.e., when someone requires assistance over a prolonged period to perform certain activities of daily living, such as bathing, eating, and dressing).

The uncapped liability from runaway LTC expenses can adversely impact a financial plan by consuming the very assets dutifully saved and invested. Costly Care Typical expenditures in retirement usually include health insurance premiums and out-of-pocket charges for acute care.

Fidelity Investments and the Employee Benefits Research Institute have separately estimated that an average couple (age 65 and enrolled in Medicare) needs about $300,000 to cover such expenses and this excludes LTC. Researchers at New York Life counter that adequate annual income is needed instead of a lump sum, and that an average retiree’s personal healthcare spending is approximately $4,500 per year. When now factoring in LTC, the published cost estimates differ based on the setting. Care delivered inside a person’s residence is typically less expensive than at a nursing home.

When now factoring in LTC, the published cost estimates differ based on the setting.

Insurer Genworth calculated the 2020 national median charges for in-home care and a private room in a nursing home to be around $54,000 and $105,000, respectively. Facility costs vary by location, reflecting the local cost of real estate and have consistently grown faster than the Consumer Price Index. The federal government’s data show that, on average, men and women have needed care for 2.2 years and 3.7 years, respectively. Furthermore, 20% of 65-year-olds today may need these support services for longer than five years.

Scaling the Pyramid: Where will the money come from to pay for this care?

The Investment Company Institute believes the answer is somewhere in a five layer retirement resource pyramid. While each household will hold these assets to a varying degree, financing sources (starting from the base and moving up) are Social Security, homeownership, employer sponsored retirement plans, IRAs, and other assets.

If LTC is suddenly required, Social Security income might be committed to other living expenses and home equity accessible through some arrangement. As is frequently the case, affected individuals may have little in the way of other assets. Such other assets might include health savings accounts (HSAs). HSA contributions, earnings, and distributions for health-related expenses, including LTC, are tax-free. Given the inherent restrictions and limitations around their use, HSAs could assist with LTC funding.

All that said, retirees may need distributions from qualified plans and IRAs to help pay for LTC. Tapping pre-tax IRAs and qualified plans will increase taxable income. Assuming a 24% marginal tax rate, every $1 in IRA withdrawals would net only 76 cents — less with state income taxes. (Note: For those itemizing deductions, the medical expense deduction could offset some of this taxation.)

Every $1 in IRA withdrawals can raise that year’s modified adjusted gross income (MAGI) dollar for dollar. The higher MAGI can affect the income-related monthly adjustment amount (IRMAA). Medicare Part B and Part D premiums may move higher, two years later, as a result. Accessing this part of the pyramid for extended care can impact other types of healthcare-related expenses in retirement. Recognizing Risk Having identified LTC as a retirement risk, we now weigh different approaches.

It’s also looking increasingly less likely to avoid steep LTC exposure as people age. The U.S. Department of Health & Human Services states that someone turning age 65 today has a nearly 70% chance of one day needing some form of LTC. For those healthy enough to qualify for LTC insurance, the risk is closer to 60% of females and 50% of males. Reducing Risk LTC is a good candidate for insurance (or pooling), because the frequency per individual is low, yet physical, economic impacts severe. Individuals differ in their risk tolerance and can respond to LTC risk (if at all) with insurance, investments, or a combination thereof. Note that exposure mitigation guides the choice of approach, which then determines the funding allocation.

Changing Class

Assume taxes are paid on elective (versus required) retirement account withdrawals. The net funds can now be classified as other assets, providing much more flexibility to respond in a crisis. Insurance offers additional leverage, because one dollar in premium can deploy multiple dollars in the event of a claim. While life insurance is a prohibited holding inside of an IRA, those same dollars can build an army outside of an IRA.

The April 2021 issue of Ed Slott’s IRA Advisor described such pooling alternatives as LTC insurance, life insurance with linked LTC benefits, and annuities. In our practice, clients choose among these potential designs by using a fact finder combined with a decision tree. The field of options includes only a particular type of annuity or a life insurance rider that does not require underwriting for LTC when a person has trouble qualifying for insurance.

Reality Check

We are working with a 64-year-old married man we’ll call Carl. Like many people, Carl’s assets are heavily skewed towards home equity and retirement accounts.

To pool, Carl can start taking elective distributions from his retirement accounts now, before he’ll face RMDs. One idea is to use a 10 x 10 strategy: $10,000 a year for ten years to purchase a life insurance policy with linked LTC benefits that are larger than the death benefit. After a decade, Carl would not pay additional premiums. The policy’s LTC benefits can grow by simple or compound rates annually to help maintain purchasing power. An alternative is traditional LTC insurance, which does not require as large an initial premium outlay.

Picking a Prudent Policy

Among the choices of life insurance policies are those with LTC riders (under IRC section 7702B) and those with a chronic illness rider (under IRC section 101[g]). Coverage may differ depending on the rider chosen. Both can offer temporary (i.e., incapacitated after a knee replacement) and permanent coverage. A 7702B policy must provide specific consumer protection provisions. A 101(g) policy may allow terminally ill or chronically ill individuals to accelerate a portion of the death benefit. A 101(g) policy cannot use the term “long-term care” in its marketing.

There are different models for payment of benefits. With a cash indemnity-style benefit, the insurer pays the contractual amount. The insured chooses to save or spend the money. Under the reimbursement option, the insurer reimburses actual outlays up to a specific limit. Fortunately, advisors can individually verify the best available rates and terms for an insured individual. The process outlined above shows how life insurance product selection can move away from dueling illustrations to focusing on an individual’s best interest.

The Public Option

Excluding informal care from family and friends, Medicaid is the primary payer of LTC expenses nationwide. This health care program, administered by states and designed for low-income segments of the population, now serves almost 71 million individuals — including those not impoverished.

The second derivative of LTC planning is for Medicaid itself, with maneuvers around income eligibility requirements and countable asset inclusion. There are still loopholes in Medicaid’s estate recovery process. Reliance on Medicaid has also triggered concerns over access to quality care and institutional bias that directs people towards a nursing home instead of their residence.

The current Medicaid eligibility rules could be more stringent for tomorrow’s retirees. Advisors will be wise to put private plans in place to deal with this unsystematic risk. Proactive use of elective retirement account withdrawals can provide the funds necessary to pool LTC risk and avoid the necessity of going into poverty to pay for LTC.

Guest Expert Ashok S. Ramji, CFP®, RMA®, LTCP, CLU®, ChFC®, RICP®, CDFA®, CAS™ TOP Planning, LLC Kirkland, WA

Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA/SIPC. Advisory Services offered through J.W. Cole Advisors (JWCA). Franklin Planning and JWC/JWCA are unaffiliated entities. Securities are not FDIC insured or guaranteed and may lose value. Investments are not guaranteed and you can lose money. This presentation is for educational purposes only and is not an offer to buy or sell an investment. Neither Franklin Planning nor JWC/JWCA are tax or legal advisors and this information should not be considered tax or legal advice. Consult with a tax and/or legal advisor for such issues.

Will Power

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Only 45 percent of adults have a will or other estate documents in place, which may not be entirely surprising.1 No one wants to be reminded of their own mortality or spend too much time thinking about what might happen once they’re gone.

But a will is an instrument of power. Creating one gives you control over the distribution of your assets. If you die without one, the state decides what becomes of your property, without regard to your priorities.

A will is a legal document by which an individual or a couple (known as “testator”) identifies their wishes regarding the distribution of their assets after death. A will can typically be broken down into four main parts.

1. Executors – Most wills begin by naming an executor. Executors are responsible for carrying out the wishes outlined in a will. This involves assessing the value of the estate, gathering the assets, paying inheritance tax and other debts (if necessary), and distributing assets among beneficiaries. It’s recommended that you name at least two executors, in case your first choice is unable to fulfill the obligation.

2. Guardians – A will allows you to designate a guardian for your minor children. Whomever you appoint, you will want to make sure beforehand that the individual is able and willing to assume the responsibility. For many people, this is the most important part of a will since, if you die without naming a guardian, the court will decide who takes care of your children.

3. Gifts – This section enables you to identify people or organizations to whom you wish to give gifts of money or specific possessions, such as jewelry or a car. You can also specify conditional gifts, such as a sum of money to a young daughter, but only when she reaches a certain age.

4. Estate – Your estate encompasses everything you own, including real property, financial investments, cash, and personal possessions. Once you have identified specific gifts you would like to distribute, you can apportion the rest of your estate in equal shares among your heirs, or you can split it into percentages. For example, you may decide to give 45 percent each to two children and the remaining 10 percent to a sibling.

The law does not require that a will be drawn up by a professional, and some people choose to create their own wills at home. But where wills are concerned, there is little room for error. You will not be around when the will is read to correct technical errors or clear up confusion. When you draft a will, consider enlisting the help of a legal or financial professional, especially if you have a large estate or complex family situation.

Preparing for the eventual distribution of your assets may not sound enticing. But remember, a will puts the power in your hands. You have worked hard to create a legacy for your loved ones. You deserve to decide what becomes of it.

1. Legalzoom.com, 2019. An adult is defined as a person age 18 and older.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2021 FMG Suite.

5 Strategies to Reduce The 2020 Tax Bill

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The American Rescue Plan Act of 2021 passed by Congress on March 10, 2021 includes many non-tax provisions to help address the COVID pandemic. There are also tax provisions in this law that may help you reduce your 2020 taxes. The IRS has extended the 2020 tax filing to May 17, 2021, giving taxpayers additional time to prepare and meet their obligations in what is becoming one of the most complicated tax seasons in decades.

The legislation calls for an additional $1,400 stimulus payment to individuals ($2,800 for joint filers) plus $1,400 for each dependent. The eligibility for the payments starts to phase out at $75,000 for individual filers and $150,000 for joint filers. Many taxpayers are not eligible for a stimulus check due to the income phase-outs, but there may be ways for you to reduce income, thereby reducing taxes and possibly making you eligible for a stimulus payment.

The Senate added tax provisions for 2020 only. Up to $10,200 of unemployment benefits are exempt from taxable income for those under the income limit of $150,000. If you have already filed your 2020 taxes, the IRS will either adjust the return to exempt unemployment or provide further guidance.

Strategies to Reduce the 2020 Tax Bill

1. SEP IRAs can be used for self-employed, franchisers, and small businesses. Employers can contribute up to 25% of each eligible employee’s gross annual salary, and up to 20% of their net adjusted annual self-employment income if they are self-employed. The contributions cannot exceed $57,000 per person for 2020.

• The deadline for establishing a SEP IRA for 2020 is extended to May 17, 2021 or (October 15, 2021 with extension) for sole proprietors.
• The deadline for establishing a SEP IRA for 2020 is March 15, 2021 (or September 15, 2021 with extension) for partnerships, LLC’s and S Corps, and April 15, 2020 (or October 15, 2021 with extension) for C Corps.

ou may participate up to the eligible limits for both the SEP IRA and the TSP if you are both self-employed and employed by the federal government. Many federal employees have a spouse that is self employed and can take advantage of this if they have not already done so.
Establishing and contributing to a SEP for 2020 will reduce your taxable income and may even allow you to qualify for a stimulus check.
2. Solo 401(k) is an individual 401(k) for a business owner with no employees. The only exception is your spouse who is working and taking taxable income from the business. If this is the case, you can both contribute to one Solo 401(k) plan. The maximum contribution for 2020 was $57,000, age 50 and over $63,000 (includes both employee and employer contributions). You have up until May 2017 of 2021 (or tax filing deadline with extensions) to establish a Solo 401(k) plan for 2020. However, only the employer contribution is permitted, which is 25% of income for the individual and a spouse. If your spouse is employed and contributing to another plan, the amount they can contribute to both employer 401(k) and Solo 401(k) is aggregated to the contribution limit of $19,500 ($26,000 if age 50 or older).

Establishing and contributing to a Solo 401(k) for 2020 before you file your tax return will reduce your taxable income and may even allow you to qualify for a stimulus check for 2020.

3. Health Savings Accounts (HSAs) provide a triple tax benefit: (1) Tax deductible contributions, (2) Tax-deferred growth and (3) Tax free income for healthcare expenses. There is no income limit to get this trifecta. HSA contribution limits for 2020: Self-only $3,550 plus $1,000 for those age 55 and older, family $7,100 plus $1,000 if HSA owner is 55 or older.
You must have been enrolled in a High-Deductible Health Plan in 2020 to contribute to an HSA for 2020.

4. IRA contribution deadline has been extended to May 17, 2021, as well. The IRA contribution limit is $6,000, plus catch up contributions age 50 and over of $1,000, as long as you or your spouse has earned income. The spousal contribution limit is $6,000, plus $1,000 if age 50 and over.

Jennifer and Joe are both age 35, are the proud parents of twins, and file joint tax returns. Jennifer works full time as a director of a large industrial cleaning company, and Joe is a stay-at-home parent to the twins.

Their only income is Jennifer’s salary of $150,000. Jennifer can contribute $6,000 to her own IRA, and Joe can make a spousal IRA contribution of $6,000 to a traditional or Roth IRA based on Jennifer’s earned income.

If you are covered by a company or government retirement plan, you may not be able to get a tax deduction for your IRA contribution. See the phase-out chart below:

Phase-Out Ranges For IRA Deductibility
This chart is only for those who are covered by a company retirement plan
Year Married/Joint Single or Head of Household
2019 103,000 – 123,000 64,000 – 74,000
2020 104,000 – 124,000 65,000 – 75,000
2021 105,000 – 125,000 66,000 – 76,000

You may also be eligible to contribute to a Roth IRA. However, there are earned income limitations that may make you ineligible.

Roth IRA Phase-Out Limits For Contributions
This chart is only for those who are covered by a company retirement plan
Year Married/Joint Single or Head of Household
2019 193,000 – 203,000 122,000 – 137,000
2020 196,000 – 206,000 124,000 – 139,000
2021 198,000 – 208,000 125,000 – 140,000

If your earnings exempt you from making a Roth IRA contribution, you may be eligible for a back door Roth IRA, but meet with a qualified professional first. Stay clear of future tax reporting problems by completing form 8606 and reporting to the IRS with your tax return. This informs the IRS, “Hey, I already paid tax on these dollars!” Use Form 8606 to report:

• Nondeductible contributions you made to traditional IRAs.
• Distributions from traditional, SEP, or SIMPLE IRAs, if you have ever made nondeductible contributions to traditional IRAs.
• Conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs.
• Distributions from Roth IRAs.

There are no income limits to contribute to the Roth TSP. If you are not already doing so, you may want to think ahead and be pro-active in your tax planning for the future by maximizing your contributions to the Roth TSP. Many people believe that taxes are on sale at present.

5. Unemployment Tax Break – While it is unlikely that you as a federal employee were collecting unemployment in 2020, perhaps your child or your spouse did. The American Rescue Plan Act of 2021 provides an unemployment tax break for 2020 tax returns: $10,200 of unemployment is not taxable for those under the income limit of $150,000. If your spouse was collecting unemployment, you should consider filing separate tax returns. The tax break is not available to those who earned $150,000 or more.

Consult with your tax professional before modifying your tax-filling strategy.

Goal Based Retirement Planning

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How do you plan your retirement? Goals based or settling? During the retirement classes I teach I often find most participants have not given any thought to their income goal in retirement. Instead, they are focused on calculating what their FERS or CSRS annuity will provide, Social Security benefit and the amount they need to withdrawal from TSP to pay their fixed expenses. I usually hear that their expenses will go down in retirement! What are you going to do with the time now that you are not working? Watch Netflix? Haven’t we been doing a lot of that during this pandemic?

I recommend quite the opposite. Start with not only determining your fixed expenses, but what are your wants and goals and what is the income you will need. Shoot for the moon to start! Whether it is traveling, volunteering, playing, golf, joining a gym or fitness studio, eating out, fishing, hunting, hobbies, and interests, getting together with friends, spending more time with your grandchildren, or your personal goals it that you would like to do during this next phase of your life. This does not necessarily mean that all your dreams will come true. This is when you decide what is most important to you and adjust, as necessary. For many of you, retirement will be 20 or 30 years. Do you want your income dictated your retirement or do you want to set goals and dreams and plan for your personal retirement?

The clients that I work with put their dreams and goals first. Once we do a retirement analysis based on personal goals, concerns and objectives we learn the likeliness of achieving them. The earlier this planning begins the more likely they can get to their goals. If you are one of those has not yet begun planning, it is never too early or too late.