Does It Make Sense to Self-Fund Long-Term Care Expense?


A related question: Does it make sense for clients to commit to paying extra taxes?

Question 1: From a financial planning perspective, which is the better option: Buying a long-term care policy or self-funding that expense?

Question 2: When you gave that answer, did you consider the tax consequences for the cost basis, which is the original price paid for an investment?

Answer: Planning ahead by buying a long-term care policy means your client doesn’t have to worry about which accounts to spend down and which to preserve, or about the capital gains implications.

Fritz Ehrsam, a financial advisor in Bel Air, Maryland, handles this issue by asking his clients to think about these questions:

  • What are the tax consequences if you need to pull money out of your brokerage account to pay the thousands and thousands of dollars for a long-term care event?
  • What happens to the taxation of your taxable investments as a result of the potential future step-up in basis?

If a long-term care policy is providing a stream of income, there should not be a need for forced investment liquidations to cover care expenses.

“If my clients can keep their money invested and not have to liquidate it to pay for their expenses, it means that long-term gains continue tax-deferred, with an opportunity for beneficiaries to receive a stepped-up cost basis,” Fritz told me. “And it may eliminate that capital gains tax.”

This step-up in basis can effectively make gains during the original owner’s lifetime tax-free for heirs.

Consider these situations:

Scenario 1: Joe, now age 85, has $1 million invested in the stock market.

Joe needs long-term care now. He did not buy a long-term care insurance policy when he was younger. His care expenses are now $100,000 a year.

To pay for this, Joe needs to liquidate some stocks.

By selling the stocks at this time, he’s facing a significant potential capital gains tax.

The question to ask is: When Joe was younger, and he could have bought long-term care insurance, would he have really preferred to give the government up to 25% or 30% of the proceeds from the stock sales?

Scenario 2: Joe has $1 million in an IRA.

If he needs to liquidate the IRA to pay long-term care expenses, the after-tax proceeds could be several hundreds of thousands dollars less than $1 million.

The question to ask — again — is: When Joe was younger, and he could have bought long-term care insurance, would he have really preferred to give the government that much of his money?

Scenario 3: At age 55, Joe was advised by his financial planner to buy a long-term care insurance policy for both him and his wife.

The policy is now paying most of his long-term care expenses.

Because he included an inflation benefit as a policy feature, his benefit amount has steadily increased over the years, meaning that the benefit has kept pace with the increase in health care costs.

And, as a small business owner, he can classify most of the premiums he’s paying for the policy as a business expense.

Scenario 4: Marie is Joe’s wife. She’s now 82.

Although she’s still in good health, she cannot easily lift him. She does she want to have to stay home 24 hours a day to take care of him.

If Joe didn’t have a long-term care policy, here’s how that would affect Marie:

  • She would be forced to be his caregiver rather than his care supervisor.
  • Because she’s younger, she would probably outlive Joe. If she and Joe are forced to sell stock to pay for Joe’s care, that means there will be less money for her to live on.

That could affect the quality of the retirement lifestyle she desires and deserves.

Margie Barrie, an agent with ACSIA Partners, has been writing the LTCI Insider column since 2000. She is the author of two books and a frequent conference speaker.




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