According to a 2013 poll from the Associated Press-NORC Center for Public Affairs Research, 25% of Americans believe they will need some form of long-term care (LTC). In reality, 70% of Americans over the age of 65 will. The difference between these numbers represents the lack of preparation and can present a huge problem for the future. I see it all the time as a significant part of my practice involves crisis planning for those who did not prepare.
So, how are people who do not have a plan for long-term care going to pay for it? One way to go about it could be using an IRA. This solution is one that a lot of people do not consider but can prove to be a lifesaver in the end. (For related reading, see: Taking the Surprise out of Long-Term Care.)
"I will have my Social Security benefit." I hear this all the time, but unfortunately Social Security will not cover the cost of long-term care. The average monthly benefit from Social Security was $1,378.92 in 2016, according to the Social Security Administration. The average monthly rate for a private room in a nursing home is $7,700, while an assisted living facility comes in at an average of $3,638.
Why an IRA?
Long-term care expenses are listed as an allowable medical cost in IRS Publication 502. Basically, this means a tax deduction is created when you use IRA money for qualified long-term care costs. Taking the full amount from your IRA means your adjusted gross income and your deductions would almost cancel each other out. This essentially turns your IRA into a tax free Heath Savings Account. This same tax strategy will not work with most other accounts you might use to pay the LTC bill. This strategy utilizes your money in the most effective way.
What About My Beneficiaries?
Leaving behind a legacy after death is very important to many people. The way you pay for long-term care will inevitably affect how much money you can leave to your heirs. If you leave an IRA, instead of using it to fund long-term care, this could require that your beneficiaries pay the taxes on this money since it will be counted as income. If you leave your taxable accounts instead, and use your IRA for long-term care expenses, current law would give them what is called a step-up in basis, meaning that they would not even have to pay taxes on the gains of these accounts. This could end up making a large difference in the amount of money left to your beneficiaries and it is definitely something to consider when paying the LTC bill.
How Do I Set This Up?
Every situation is different. Using IRA money will not be the best choice for everyone. If you already have insurance to cover LTC, then you might never need to draw from an IRA or even your Social Security, because everything could be covered. But if self-insurance is your plan or you have no plan at all, the first step you need to take is getting your legal documents together. While there are a few documents you should update regularly, the financial power of attorney is extra important in regards to LTC. A financial power of attorney will allow the agent named to manage your IRA and direct the distributions to your LTC payments if needed. (For related reading, see: Alternatives to Long-Term Care Insurance.)
Are There Any Other Options?
If you are still relatively young and healthy, there are ways to maximize your IRA before the need for long-term care arises. This involves life insurance. There are certain companies that have patents on products which, in simple terms, take money from your IRA to fund a life insurance policy with a rider that will pay for long-term care. These policies can get very complicated and are not the right choice for everyone, but just know that these are out there and do exist.
Planning for long-term care is something that many people avoid and when this happens, it can get very complicated and expensive. While the best option is to have a plan in place before needing long-term care, there are strategies to pay the bill if there was no plan in place. Make sure to do your research and/or contact a professional if you find yourself in this situation. It could save you thousands of dollars in the end. (For more from this author, see: Don't Forget Long-Term Care in Retirement Plans.)
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