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Retirement Planning's |
Pension and Retirement Memo |
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In my last memo I wrote about the new Medicaid laws that went into effect this year. Two of those new rules --- the five year look-back and the deferred starting date for Medicaid ineligibility --- make planning for long term care ("LTC") much more difficult. I hit a lot of "hot buttons" with my readers. In the seventeen years I have been writing these memos, I have never received so many responses. I read everything I can on estate planning and retirement planning -- newspapers, books, professional journals, and websites. I am surprised at how little attention has been paid to these new Medicaid rules and how they threaten the financial security of families. The new rules have spawned a "new dragon to slay" -- how to pay for your long term care. I call long term care the "new dragon" because it replaces the "old dragon" to financial security, the estate tax. Let's see what this new LTC dragon looks like, how it differs from the old dragon, and why the weapons used against the old dragon are useless against this new foe. The Old Dragon Putting the new LTC dragon into perspective requires looking at the old dragon -- the estate tax -- and how we deal with it. The federal estate tax has been the planner's monster for generations. Over the last twenty years, a tax that was intended to hit only the very wealthy began threatening the middle class. Inflation had eroded the protection of the $600,000 exemption. Congress eventually responded by increasing the exemption (currently $2 million) and, one expects, when Congress finishes its job, the estate tax will affect only the very wealthiest. For most of us, the estate tax dragon has been pushed back into its cave. The estate tax dragon, for all its fire-breathing fury, can be defeated. Armies of estate planning lawyers, with the help of the insurance and financial planning industries, have developed weapons to contain the estate tax dragon for most clients. Trusts, lifetime gifting, charitable arrangements, second-to-die insurance policies, private annuities, family limited partnerships, and so on are in the estate planner's arsenal. Just look at the lexicon of our weapons --- QTIP's, GRAT's, GRIT's, QDOT's, CRAT's, CRUT's, QPRT's, IDGT's and FLP's, to name a few. Estate planners have as many acronyms as the Pentagon. Many planners view the estate tax as voluntary, since there are so many devices to avoid or defer it. The tactics for fighting the estate tax dragon are routine. A little planning goes a long way, and last minute planning is common. There is no urgency for clients under age sixty, as effective planning usually starts late in clients' lives. There is no tax at the first death of a married couple, and the survivor has many options. Even where the estate tax dragon strikes, its damage is mitigated. The tax is paid after the death of the client and surviving spouse, so the economic harm is inflicted on the heirs. The estate tax, at its worst, diminishes a client's wealth by only one-half over and above generous exemptions, and after cumulative lifetime gifting. Inheritances are income tax free, and they come with a stepped-up basis. Finally, the wealth that is consumed by the estate tax can be replaced, income and estate tax free, with properly owned life insurance. The New Dragon The new dragon --- long term care expenses --- is by far a more formidable, deadly beast. Here's why. First, the new dragon affects a huge group. While estate taxes are paid by 1% of all estates, long term care expenses threaten almost the entire population. The very poorest will be covered by Medicaid, and the very wealthiest can self-insure. The rest of us in the middle are at risk. The statistics are chilling. If a married couple are 65, there's a 70% chance that one will need LTC. If you are over 75, there's a 60% chance you'll need LTC. Second, if the new dragon strikes, you can lose everything, not just one-half after exemptions. Third, you suffer the damage, both financial and emotional, during your lifetime. Consider the anguish of watching your wealth drain to pay for LTC when the only two solutions are either (i) dying before everything is gone, or (ii) qualifying for Medicaid after all is lost. Fourth, planning is much more difficult for LTC than for estate taxes. The new five year "no-fly zone" on property transfers makes gifting for artificial impoverishment --- the standard weapon under the old Medicaid rules --- obsolete. Even bona fide gifts, such as those to pay for tuition and charitable contributions, get sucked into the five-year net. Attacking the New Dragon There are solutions, but they are not the ones we use to against the estate tax dragon. The solutions include insurance and planning. Insurance Long term care (LTC) insurance is now a necessity. Connect these dots. Nursing home expenses now run from $200 to $300 per day. Can your current assets generate the $100,000 or so each year to cover that without touching principal? Now, factor in inflation. Suppose you are 60 years old. Even with moderate inflation, costs will double in ten to twelve years. By the time you're in your eighties, double that again. If you're married, double everything. My arithmetic is simplistic. Try it yourself with different assumptions on inflation, costs, investment returns, and life expectancies. No matter how you run the numbers, you will most likely conclude that you cannot afford to pay long term care expenses for you and your spouse for more than a few years. That being the case, insurance is your most cost effective protection. But, you say, the odds of needing long term care is small, so you'll take the risk and do nothing. Perhaps. However, I could say the same about fire insurance on my house. The likelihood of my house burning is small, but I buy fire insurance anyway. Insurance makes sense when the cost of the insurance (whether LTC insurance or homeowner's insurance) is affordable to protect against an unlikely but nonetheless calamitous event (LTC costs or my house burning down). Planning LTC insurance is not the sole solution. You still have to do your homework and plan. There are several reasons. First, you will find that selecting LTC insurance is not simple. You don’t get it off the shelf at Wal-Mart or on-line at Amazon.com. It is a complicated purchase because policies vary so much. It seems you are always comparing apples to oranges to pears. You can't shop on price alone. Do you want a long or short elimination period? Is home care covered? What else is covered, what is not? Will premiums increase? Is there inflation protection, and how much extra does it cost? What happens if you move to another state? How financially strong is the insurance company issuing the policy? My advice is to talk to a LTC insurance pro. Mistakes in policy section are critical, as switching to a new policy later may be very expensive or impossible. Second, when planning for insurance, much of the premium can be tax deductible. You cannot make a correct decision on LTC insurance without trying to purchase it with pre-tax dollars. Where you live is important. There can be an advantage to move to a state where LTC costs are lower. Many elders end up living close to their adult children. Even though you retire in Florida or Arizona, you may eventually move to Illinois to be close to your daughter. Fourth, rethink your retirement plan funding and investments. Many assume, incorrectly, that they'll need less income in retirement. That is not true if you factor in LTC expenses. Postponing retirement a year or two can give you a better cushion. Saving more (gasp!) and taking on more investment risk in your 401(k) may be necessary. Will you work in retirement? ("Welcome to Wal-Mart"). Conclusion Long term care costs have replaced estate taxes as the big financial threat for many of us. However, there are solutions, which include insurance and professional planning. There are many excellent web sites covering LTC. Go to Google and enter "long term care insurance." Eugene Parrs |
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© 2008 Eugene Parrs |
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