Estate planning is about much more than reducing taxes; it’s about ensuring your loved ones are provided for after you’re gone and that your assets are passed on according to your wishes. However, few events can upend your estate plan as the way unanticipated long-term care (LTC) expenses can.
LTC expenses generally aren’t covered by traditional health insurance policies, Social Security or Medicare. Thus, to preserve as much wealth as possible to pass on to your family, it’s critical to form a plan to fund any LTC expenses.
Paying out-of-pocket
If your nest egg is large enough, it may be possible to pay for LTC expenses out-of-pocket as (or if) they’re incurred. An advantage of this approach is that you’ll avoid the high cost of LTC insurance premiums. In addition, if you’re fortunate enough to avoid the need for LTC, you’ll enjoy a savings windfall that you can use for yourself or your family. The risk, of course, is that your LTC expenses will be significantly larger than anticipated, eroding the funds available to your heirs.
Any type of asset or investment can be used to self-fund LTC expenses, including savings accounts, pension or other retirement funds, stocks, bonds, mutual funds, or annuities. Another option is to tap the equity in your home by selling it, taking out a home equity loan or line of credit, or obtaining a reverse mortgage.
Two vehicles that are particularly effective for funding LTC expenses are Roth IRAs and Health Savings Accounts (HSAs). Roth IRAs aren’t subject to minimum distribution requirements, so you can let the funds grow tax-free until they’re needed. And an HSA, coupled with a high-deductible health insurance plan, allows you to invest pretax dollars that can be withdrawn tax-free to pay for qualified unreimbursed medical expenses, including LTC. Unused funds may be carried over from year to year, making an HSA a powerful savings vehicle.
Buying LTC insurance
LTC insurance policies — which are expensive — cover LTC services that traditional health insurance policies typically don’t cover. Determining when to purchase such a policy can be a challenge. The younger you are, the lower the premiums, but you’ll be paying for insurance coverage during a time that you’re not likely to need it.
Although the right time for you depends on your health, family medical history and other factors, many people purchase these policies in their early to mid-60s. Keep in mind that once you reach your mid-70s, LTC coverage may no longer be available to you.
In evaluating LTC insurance, be sure to find out whether your employer offers a less costly group LTC policy.
Be sure to also consider hybrid insurance policies. They combine LTC coverage with traditional life insurance. Often, these take the form of a permanent life insurance policy with an LTC rider that provides for tax-free accelerated death benefits in the event of certain diagnoses or medical conditions.
These policies can have advantages over stand-alone LTC policies, such as less stringent underwriting requirements and guaranteed premiums that won’t increase over time. The downside, of course, is that to the extent you use the LTC benefits, the death benefit available to your heirs will be reduced.
Understanding available tax benefits
Be aware that there are tax benefits available that can help offset some LTC expenses. If you self-fund the cost of your LTC, your out-of-pocket expenses generally will be deductible as medical expenses, but only if you itemize deductions on your tax return. Medical expenses are deductible to the extent they exceed 7.5% of your adjusted gross income (AGI).
If you purchase LTC insurance, any benefits you receive will not be taxable. In addition, if the policy is “tax qualified,” you’ll be entitled to deduct a portion of your premiums.
A tax-qualified policy is one that’s guaranteed renewable and noncancelable regardless of health, doesn’t condition eligibility on prior hospitalization and doesn’t exclude coverage based on a diagnosis of Alzheimer’s disease or dementia. The policy must also meet certain other requirements.
Keep in mind that LTC premiums are treated as medical expenses, which are deductible only to the extent they total more than 7.5% of your AGI and only if you itemize. Also, be aware that tax-qualified policies may have higher premiums and stricter eligibility requirements than nonqualified policies, so weigh the advantages of tax deductibility against the potential disadvantages of a qualified policy.
Turn to your advisor
While no one wants to contemplate the need for LTC, it’s good to know that there are several potential strategies for funding the associated expenses. Your advisor can help you find which option is best for you and your family.
