The Perils of Paying Long-Term Care Expenses from Your Tax-Deferred Bucket with David McKnight

If you’re between the ages of 50 and 65, there is a good chance that you have at least one parent or in-law that is going through a long-term care event. This may lead you to wonder how you are going to deal with your own long-term care events in the future.

The government may be picking up the tab, but people in Medicaid-funded long-term care facilities tend not to live as long as at other facilities.

A lot of people in that age range have a false sense of security around how they are going to finance their long-term care events, assuming they will be able to pay for everything out of their IRA or 401(k).

The average stay in an assisted living facility is just over two years, but research shows that people receive some form of long-term care in their home for an average of three to six months. Sixty percent of those people in the assisted living facility will go on to spend up to an additional two years in a nursing home.

When you add up the averages, you can expect to be in some sort of long-term care situation for four to five years, which is much longer than most people think is the case.

Long-term care costs are not uniform across the country, but you can expect to spend around $100,000 after taxes per year of long-term care. There are other expenses that people don’t think about known as shock expenses. These can include things like unexpected health care costs. All told, you can expect a total cost of somewhere around $400,000 a year.

In order to net just $100,000 in distributions you need to figure out your effective tax rate, but you also have to keep in mind that since tax rates are going to be dramatically higher in the future those numbers are going to increase as well.

People who will need long-term care in the future may have to deal with an effective tax rate of 40%, which means you would need $166,000 before taxes to cover your long-term care expenses. And that’s assuming the costs of long-term care don’t rise in the next twenty years, which is highly unlikely.

Are you going to have over $1 million in your IRA’s and 401(k)’s at the age of 85? Most people tend to spend the majority of their retirement money in the early years when they are still mobile.

In a rising tax rate environment, it is not a smart move to pay for your long-term care out of your tax-deferred bucket. This is why the L.I.R.P. is something we recommend to cover your long-term care expenses.

With an L.I.R.P., you can spend your death benefit in advance of your death in order to cover long-term care expenses. Instead of waiting and hoping you have enough money when you need it, why not proactively pay taxes on that money and position them in tax-free vehicles like the L.I.R.P.? That way, you can have guaranteed access to the cash when you need it.

We have to remember that tax rates in the future are going to be much higher than they are today and long-term care costs are likely to be much higher as well. If we can pay taxes preemptively, we are going to be in a much better position to pay for these long-term care costs.

If you are between the ages of 50 and 65, you are likely in a position to do something about your long-term care needs without the heartburn that a generation of Baby Boomers are likely to feel. Medicaid doesn’t step in until you have spent all your money as a married couple down to $128,000 and is the least efficient way to pay for long-term care.

You can literally burn through a lifetime’s worth of savings in just a couple of years because you didn’t plan ahead of time and are forced to pay for long-term care expenses out of your tax-deferred bucket.