Long-term Care - Part 3: Strategies for Funding LTC
In the first post in the long-term care (LTC) series, the sizable financial risks of LTC were discussed. In the second post, LTC insurance options were review. In this third and final post in this series, various strategies for funding LTC are explored. Many of these options can be mixed and matched as needed to fit with your own situation. Also, note that there can be many details to consider with some of these strategies (e.g., irrevocable trusts, Medicaid compliant annuities), so it is wise to consult an elder care attorney to help you with planning.
Also, remember that Medicaid provides a backstop to LTC expenses in most situations, so the primary purpose of the strategies for funding LTC outlined here are to protect your assets, not to ensure that you will receive LTC in the event that you truly need it.
Overall, strategies for funding LTC can be broadly separated into those that (1) rely primarily on Medicaid to pay for LTC, (2) plan on self-insuring LTC and only use Medicaid as a backstop to the primary funding plan, and (3) use a combination of self-insuring and LTC insurance. These strategies are each discussed below.
Relying on Medicaid
Most of those of the age where LTC is necessary do not have enough assets to justify expensive strategies to protect them, including LTC insurance. In 2020, 50% of Americans aged 70-74 had a net worth of $100,000 or lower, excluding home equity. If such people incur significant LTC expenses, most will have little choice but to quickly deplete what assets they have to the point that they qualify for Medicaid. However, there are a few options such folks can use to help protect what assets they have from being depleted before they can qualify for Medicaid.
Recall that in most states, qualifying for Medicaid benefits requires depleting one's 'countable' assets to no more than $2,000. This includes most assets (e.g., checking and savings accounts, taxable brokerage accounts, life insurance policies with cash value), but there are some notable exceptions that are 'non-countable' for Medicaid purposes and do not have to be depleted for applicants to qualify for Medicaid. Before age 70.5, the assets in an IRA are countable, but after age 70.5, the assets in an IRA are non-countable. However, the income they produce, including required minimum distributions (RMDs), is countable. For this reason, Roth IRAs, which do not have RMDs, can be particularly useful in this situation, and those who plan to rely on Medicaid would likely do well to convert a substantial portion of their tax-deferred assets to Roth accounts.
One's home is generally a non-countable asset, but after your (and, if applicable, your spouse's) passing, your state's Medicaid agency may take the property to recover the funds it used for your care.
Irrevocable trusts can be effectively used to make assets non-countable. As its name implies, an irrevocable trust cannot be modified in any way in most states. The assets placed into an irrevocable trust are usually non-countable by Medicaid if they have been in the trust for five years prior to the application for Medicaid benefits. Assets in the trust cannot be distributed to the grantor (i.e., the person who created it), but the income it produces can be, such as dividends, interest, and real estate income. Tax-deferred assets cannot be placed into an irrevocable trust, so these assets must first be withdrawn and income taxes paid on the withdrawal before the remainder can be placed into the trust. Placing one's home into an irrevocable trust is a very useful way to ensure that it passes through to heirs and will not be taken by your state's Medicaid agency. There are many other important details to consider with an irrevocable trust, so those considering one should certainly speak to a reputable elder care attorney licensed in their state.
Another, potentially less useful, option for married couples relying on Medicaid to pay for LTC is a Medicaid compliant annuity (MCA). If there is a need for LTC for one spouse that is likely to deplete most or all of a married couple's assets, an MCA may then be purchased for the well spouse. States have fairly low thresholds on the assets of the spouse not applying for Medicaid benefits. Assets exceeding this threshold that would otherwise have to be spent before qualifying for Medicaid could be used to buy an MCA. However, life annuities do not qualify; only period certain annuities are permitted (i.e., annuities that pay for certain period of time), and the period must be no longer than the well spouse's life expectancy. If the well spouse passes away before the period ends, Medicaid receives the remaining payments. This strategy seeks to protect some of the couple's assets for the well spouse by that person continuing to receive payments from the MCA long after the other spouse passes away. Some portion of those payments could be retained for the real possibility that the well spouse lives beyond the period in which the MCA provides payments. But the inability of an MCA to provide lifetime payments for the well spouse decidedly limits its usefulness.
The simplest way to fund LTC expenses is to just pay for them if/when they come up (i.e., self-insure the risk). Given that in 2017 there was a 30% likelihood of a single individual incurring LTC expenses of $200,000 or more and a 7% likelihood of incurring over $500,000 of such expenses, this strategy requires significant assets. Given subsequent inflation, in 2022 these expenses would be roughly $250,000 and $600,000, respectively. However, it is very possible that those who have been blessed to have substantial assets saved for their elder years can pay for such possible expenses. There is no bright line to indicate precisely what level of assets someone needs to self-insure LTC, but for a married couple, the threshold is likely at least $1 million, and $2 million or more is more than ample.
Self-insuring requires both a willingness to spend down a significant portion of one's assets to pay for LTC expenses and, in the case of married couples, an ability to do so while still leaving adequate assets behind for the well spouse. One's willingness to pay for LTC expenses from one's assets should not be overestimated. It's one thing to think about paying $400,000 for LTC, for instance, but quite another to actually take that big of a potentially permanent reduction in one's nest egg (or an even bigger one). As noted in the second post in this series, many with the clear ability to pay for their LTC are unwilling to do so out of fear that this will eventually deplete their assets, resulting in them unnecessarily burdening their family and/or friends to provide them with the care they need.
Determining if one has the ability to pay for LTC expenses and have enough assets remaining to care for the well spouse's needs depends on many factors. One of the most important factors for many couples will be how their living expenses compare to their Social Security benefits (and/or pension payment). The more of their living expenses that are covered by Social Security benefits, the more able they are to spend a large portion of their assets on LTC expenses. If there is a shortfall between their living expenses and Social Security benefits, then they should consider how that shortfall could be reduced, eliminated, and/or funded in a situation involving major LTC expenses.
For instance, let's consider a couple with a portfolio of $1 million, $80,000 of living expenses, $30,000 of Social Security benefits for one spouse, and $15,000 of Social Security spousal benefits for the other. Apart from other income sources, this couple would need to withdraw $35,000 from their portfolio on a regular basis to fund their regular living expenses, which has historically been very safe. Now let's say that the spouse with the $30,000 of Social Security benefits incurs LTC expenses of $500,000 before passing away (recall that this is greater than what approximately 85% of retirees spent on LTC in 2017, adjusted for inflation). The surviving spouse has $500,000 remaining in the portfolio and now receives the $30,000 Social Security benefit that the well spouse did and has $500,000 remaining in the portfolio. Using 4% as an estimate for how much can be withdrawn from the portfolio, that means that the surviving spouse would have $50,000 of income remaining. For this to be sufficient, the surviving spouse's living expenses would need to be $30,000 lower than when both spouses were alive.
Those who have a large portion of their assets in tax-deferred accounts (e.g., 401(k) plans, traditional IRAs), can potentially pay for substantial LTC expenses very tax efficiently. Qualified medical expenses greater than 7.5% of one's adjusted gross income are deductible from federal income taxes, which can significantly reduce one's tax burden. However, recall that it is only worthwhile to claim deductions if they exceed the standard deduction, which is $25,900 for married couples filing jointly. This means that if one spouse in a married couple incurs $100,000 of LTC expenses in a calendar year that are fully deductible and the couple has an adjusted gross income of $60,000, $95,500 of the expense would be deductible (i.e., $100,000 - [$60,000 x 7.5%]). As such, the couple could withdraw $69,600 (i.e., $95,500 - $25,900) more from tax-deferred accounts than they could have apart from the LTC expenses and pay zero federal income tax on the $95,500 withdrawal.
In the event that you are using tax-deferred assets to pay for significant LTC expenses in this manner, are under age 70.5, and have sufficient assets to do so, this could also be a good time to donate to charity and/or a donor-advised fund since you have already have enough deductions to exceed the standard deduction. After age 70.5, this strategy isn't as helpful because you can then make qualified charitable distributions instead, as discussed in this post.
One should also be concerned about the real possibility of both spouses in a married couple incurring large LTC expenses. Research suggests that one spouse needing LTC leads to the other spouse needing LTC much more often than expected. During the first year of one spouse needing LTC, the likelihood that the other spouse will also need LTC increases by about 350%! For this reason, those planning on self-insuring LTC should plan on both spouses needing significant care.
Combining Self-insuring and LTC Insurance
As noted in the second post in this series, Continuing Care Retirement Communities (CCRCs) can be a great means of allowing seniors to age in place and receive a level of care that corresponds with their needs. Many CCRCs offer lifetime care contracts, and while these are not a form of insurance, but they act somewhat similarly to insurance. These contracts stipulate that residents will receive whatever care they need for the remainder of their lives. Some of these contracts require the residents to continue paying a set fee as long as they are financially able to do so, while others do not require such a fee. Prices for these contracts range from around $40,000 to several hundred thousand dollars for one person. This can sidestep the need for LTC insurance, but as cautioned before, those considering this option need to carefully evaluate the CCRC and whether they are likely to be able to hold up their end of the contract, along with whether residents can exit the lifetime care contract if desired.
Traditional LTC policies that qualify under the Long-term Care Partnership Policy, which are available in 44 states, can be an effective means of protecting a well defined amount of assets from Medicaid. These policies protect an amount of one's assets from Medicaid that is approximately equal to the benefits that the policy pays before being exhausted, and the cost of a Partnership-qualifying policy is no more than that of a similar, not qualifying policy. Unlike hybrid LTC policies, these policies are fairly simple and straightforward.
Partnership-qualifying policies essentially provide 'double protection' because the policy will pay for a certain amount of LTC, and approximately that same amount of one's assets will then become non-countable for the purpose of qualifying for Medicaid. For this reason, it's prudent to consider buying a policy with enough benefits that even if they are exhausted, there would be enough assets protected from Medicaid to provide for the well spouse. But these policies can have rather stringent health qualifications, so those interested in buying one should do so before age 65 and preferably before age 60.
Those blessed with substantial (i.e., over $100,000) of fixed income assets that they are very unlikely to ever need might consider buying a hybrid LTC policy with unlimited benefits and a long elimination period with those funds (i.e., at least one year and preferably longer). The reason for this stipulation is that most or all the potential growth in the premium(s) of a hybrid LTC policy is lost, but there isn't much potential growth with fixed income assets anyway, and those unlikely to need these assets in their lifetime can use them in this way to provide cost-effective protection from the risk of very expensive LTC.
Due to the presence of Medicaid, planning for funding LTC is more about protecting one's assets from being exhausted than it is about receiving LTC. Most retirees don't have enough assets to self-insure the financial risk of LTC nor the need to buy LTC insurance to protect their assets, but they may be able to take steps to protect what they have through (1) converting tax-deferred funds to Roth IRA funds, which are both non-countable by Medicaid and have no RMDs, (2) creating an irrevocable trust to make their home and other assets non-countable, and (3) buying a Medicaid-compliant annuity to provide some protection for funds that can be used in the future by the well spouse.
Self-insuring becomes increasingly plausible once one has at least $1 million in assets and particularly so with $2 million or more, but this strategy requires both a willingness to pay potentially sizable LTC expenses and the ability to do so while retaining enough assets for the well spouse. Tax-deferred assets can be used to pay for hefty LTC expenses in a very tax efficient manner also, and those considering self-insuring can still benefit from the judicious use of irrevocable trusts as well, particularly for protecting their home.
LTC insurance can be useful for those who are unable to self-insure but wish to protect assets beyond what can realistically be done with IRAs, irrevocable trusts, and Medicaid-compliant annuities. Traditional LTC policies that are Partnership-qualified make the most sense here as they essentially provide 'double protection', though hybrid LTC policies with unlimited benefits and long elimination periods can make sense for those who have significant fixed income assets that they are unlikely to ever need. With any insurance option, the opportunity cost of the using the premiums to buy the policy should be carefully considered.
Without a doubt, LTC expenses are one of the biggest financial risks facing retirees today, and those who have diligently saved and been blessed to have significant assets should examine how they can best protect those assets for their spouse, heirs, and/or charity. There are no inexpensive, easy, one-size-fits-all solutions. Rather, each person's risk tolerance, asset level and mix, health, desire for a bequest, family situation, etc. should be taken into account when forming a plan.