"Quality Estate Planning at Discounted Rates"
At our sister law firm, Long-Term Care Advisors, LLC, we examine all potential avenues for providing for clients' long-term care, especially for clients approaching or already at retirement who are not participants in a corporate pension plan (which typically pays significant monthly benefits for life). Long-Term Care Advisors, LLC's focus is on leveraging the clients' existing IRA or other qualified plan benefits to provide for their long-term care needs, at the lowest possible after-tax cost, in effect creating a "private pension plan" for the clients.
This article by Mr. Blase illustrates the "holistic" approach which Long-Term Care Advisors, LLC takes to long-term care planning for its clients:
The Holistic Approach to Long-Term Care Planning
James G. Blase, CPA, JD, LLM
Principal, Long-Term Care Advisors, LLC
The American Heritage Dictionary of the English Language defines the word “holistic” to mean: “emphasizing the importance of the whole and the interdependence of its parts.” As this article will demonstrate, holistic is the approach which advisors must take to long-term care planning, today, if we are truly to do our part to help mitigate the effects of what I will term “the long-term care crisis,” which is surely to hit our country, by mid-century.
"Importance of the Whole"
It would of course be a waste of toner ink to repeat that the baby boomers are all getting older, we are all living longer, the cost of long-term care continues to rise, etc., and as a direct consequence the need for long-term care, as well as the cost of the same, will continue to compound, over at least the next 35 years. This much is self-evident. What is less evident, I think, is the primary reason for my assertion that there will be a long-term care crisis by mid-century. And this primary reason is the demise of the traditional corporate pension plan.
Since retiring from the corporate world at age 60, my 85-year-old father has often asked me whether my mother and he should purchase long-term care insurance, and my response has always been the same: “You guys already have long-term care insurance - the great lifetime pension plan mom and you have from your job.” And my father’s lifetime pension plan is just that - a long-term care insurance plan, whether anyone realized that before, or not.
“Interdependence of its Parts”
But what about the rest of us, those being basically the beginning of the baby boomer generation, and younger? Most of us in this era no longer enjoy the benefits of a corporate pension plan or, if are lucky enough to have a pension plan, it often still is not sufficient to meet all of our potential long-term care needs. What are we to do, to plan for our potential long-term care needs? Purchase a long-term care insurance policy, or one of the fancy new life insurance or annuity “hybrid” alternatives thereto? Self-insure? Do so-called “Medicaid planning?”
I submit that it is not any one of these myriad of possibilities, by itself, which will solve the long-term care crisis for our clients, but rather a carefully crafted combination of the same, specially designed to meet the needs of each particular individual or married couple, separately. And in order for this individualized planning to occur, various professional advisory disciplines must be utilized and eventually overlap, or “converge,” to develop a holistic long-term care solution for each individual client or couple. These various and overlapping professional disciplines include retirement planning, income tax planning, insurance planning and estate planning.
Retirement Planning Component
As already mentioned, there is no better “long-term care plan” than a solid and significant corporate pension plan, especially one which pays a significant survivor benefit for the lifetime of the surviving spouse. The reason for this is that the true or “traditional” corporate pension plan pays a lifetime benefit, so there is no fear of outliving the “long-term care” benefit, as there may be with typical forms of long-term care insurance (excepting a policy with a lifetime benefit) and/or traditional or hybrid life insurance. The only issue when an individual is the beneficiary under a traditional pension plan is making sure that this benefit, teamed with the individual’s other forms of retirement benefits, including annuities and social security, will be sufficient to cover anticipated potential long-term care costs. If it is determined that they may not be sufficient, then the balance of this article becomes relevant.
So what are just some of the retirement planning techniques currently available, which may aid in the long-term care planning process? First and foremost, I think that it is imperative that the retirement planning advisor make it a point to factor in and highlight to the clients not only the “normal” costs of retirement, but also at least some of these potential long-term care costs, which, of course, could turn out to be astronomical. This will place the clients in a position to better understand the gravity of the long-term care issues involved, and at a very minimum convince the clients of the need to budget, during their pre-retirement years as well as during their retirement years, along with the need to invest a portion of their retirement savings for long-term growth, as opposed to current return.
I think the next most important aspect of retirement planning, as it overlaps with long-term care planning, is to take advantage of the various outlets already available today, to push a portion of one’s retirement income to what I will label the “later” retirement years, e.g., ages 85-95, when the potential long-term care expenses we have been discussing will most likely arise. This obvious also requires discipline on the part of the clients.
One of the most obvious “deferral” techniques currently available to push more retirement income to one’s later years is to adopt the discipline of waiting to withdraw social security until the maximum annual level is achieved, thereby maximizing the annual social security benefits which the individuals will receive in their later years. Difficult in the short run, but from a long-term care perspective, this discipline is well worth the effort, in the long run.
Another “deferral” avenue currently available results from the change in the required minimum distribution rules which now allow for the deferral of IRA and other qualified plan benefits over the joint lifetimes of the participant/owner and a hypothetical beneficiary who is 10 years younger. Theoretically, then, if the clients are disciplined enough to take only the minimum required distributions during their pre-age 85 years, there should be that much more retirement money available to them, during their post-age 85 years.
Still another excellent retirement planning technique aimed at producing more funds for the long-term care years, is the new Qualified Longevity Annuity Contract, or QLAC. First authorized by the IRS in July of 2014, the QLAC allows each participant to apply the greater of $125,000 or 25% of his or her IRA or qualified plan benefits, towards the purchase of a deferred annuity inside of the IRA or qualified plan, which will not require required minimum distribution payments until an age selected by the owner or participant, up to age 85. The application of the new QLAC to long-term care planning is obvious - more guaranteed moneys, for the individual’s long-term care years. The purchase of regular nonqualifed annuities can produce similar benefits from a long-term planning standpoint, although nonqualified annuities are obviously purchased with after-tax moneys.
Income Tax Planning Component
The overlap (or convergence) between the various professional disciplines described above begins to take shape when the income tax advisor considers the income tax effect of deferring more retirement income into the long-term care years, i.e., generally age 85 and following. Because the cost of long-term care is generally income tax deductible, it is actually possible to turn all or a significant portion of the newly-deferred retirement savings (including even social security benefits) into income which is effectively tax-free, i.e., because of the medical expense deduction. Thus, in effect, the income is tax deductible (or excluded) going into the qualified plan or taxable IRA and, effectively, income tax-free coming out.
A similar treatment to that of taxation of distributions from taxable IRAs is afforded nonqualified annuities, although, again, the same are purchased with after-tax moneys. If both sides are agreeable, it is now also possible to the roll the proceeds from nonqualified annuities directly in to long-term care insurance, without the need to report the income from the annuity. Hopefully these types of “tax-free rollover” arrangements will become more widely accepted in the coming years.
A potentially even more favorable tax treatment may accompany the use of Roth IRA proceeds for long-term care. While Roth IRAs are also purchased with after-tax moneys, because the proceeds are received income tax-free, there is actually a potential double tax benefit when the Roth IRA proceeds are used to pay long-term care expenses; in other words, tax-free receipts used for tax deductible expenses.
Still another potential income tax strategy is to structure a married couple’s estate so that, to the maximum extent possible, at the death of the first spouse the income tax basis of the surviving spouse in the couple’s assets is “stepped-up” to the value of the same at the first spouse’s death. When assets are then eventually liquidated by the surviving spouse in order to pay long-term care costs, capital gain taxes are reduced, and in effect so too is the after-tax cost of the surviving spouse’s long-term care.
Insurance Planning Component
Income tax planning is a natural lead-in to our discussion of the insurance planning component of long-term care planning, since most insurance planning includes one or more tax favored elements.
Traditional long-term care insurance, for example, can often be purchased on an all or partially tax deductible basis (including, in many instances, an additional state income tax deduction). If the nonqualified annuity tax-free rollover approach (discussed above) is available, this will normally be an even more beneficial income tax savings route to pursue. And, of course, the benefits payable under a traditional long-term care insurance policy are income tax-free. The benefits of a state partnership long-term care insurance plan should also be examined, if available in the client’s state.
The newer life insurance and annuity hybrid policies, which pay optional lifetime long-term care benefits in addition to life insurance or annuity benefits, provide the client with a guaranteed return on his or her investment, regardless of whether a long-term care need should ever arise. Although the premiums on these policies are not tax deductible, this “guaranty element” will be difficult for most clients to pass on, especially when the life insurance or annuity contract is purchased for other reasons also, e.g., for the protection of dependents and/or as an additional retirement planning benefit.
Another overlapping income tax strategy presents itself when the subject of funding sources for any of the insurance planning concepts referred to above is raised. Most clients who are interested in one or more forms of long-term care insurance protection have the majority of their savings tied up in their 401ks or IRAs. Does it make sense to withdraw a portion of these quailed moneys early, to help fund a long-term care product? Of course any withdrawals before age 59-1/2 would need to qualify for as an exception to the normal 10% penalty tax, under Section 72(t) of the Internal Revenue Code (normally as a series of substantially equal periodic payments), but assuming this hurdle is met, “after-tax math” comes into play to determine whether, assuming the client is concerned about providing for his or her long-term care, it makes sense to withdraw taxable funds early, to invest in one or more of the forms of long-term care insurance, on a taxable or partially tax-deductible basis. A professional proficient in income tax planning can analyze this situation for the client.
Estate Planning Component
Note that the component here is intentionally labeled “estate planning,” and not “eldercare planning.” While both disciplines are concerned with planning for Medicaid and/or VA benefits, the distinction is that the focus in estate planning tends to be on the “long-term” aspect of the long-term care planning involved, whereas the focus in eldercare planning tends to be later in the game, and more on the short-term, so much so that in many instances the planning involved should better be referred to as “crisis planning,” for the client is typically either already about to enter a nursing facility or will likely need long-term care within five years. In the truest of crisis situations, the purchase of a so-called “Medicaid annuity (which is beyond the scope of this article) should be considered.
There are two basic subcomponents to the estate planning component: estate planning to qualify for government benefits during the client’s lifetime, and estate planning to qualify for government benefits after the death of the first of a married couple to die. Both are important. Both should also be considered along with all of the other multidisciplinary components described above, because it will be a rare case that one or more of these other components will not be needed to compliment the overall long-term care plan.
Basic lifetime estate planning for Medicaid benefits, for example, requires that the bulk of the client’s assets be transferred away at least five years prior to applying for Medicaid benefits. The problem with this singular form of planning, however, is that in most instances the client has an IRA or other qualified plan asset which comprises a significant portion of his or her estate. In order to give such an asset away at least five years prior to applying for Medicaid, significant income taxes would need to be paid immediately. This will rarely, if ever, be considered a wide path to follow. The example at the end of this article presents one possible solution to this dilemma.
Estate planning’s primary role in long-term care planning involves the use of trusts - trusts which are established during the lifetime of the client, as well as trusts which are established for the surviving spouse upon when the first of a married couple passes. Trusts set up during the client’s lifetime are normally designed to fully qualify under the “five-year waiting period” test for Medicaid nursing home benefits, while providing the client with the greatest protection possible, and lowest income taxes possible.
Thus, the client normally retains the full and exclusive right to live in his or her residence for life (along with the client’s spouse, if any), including any new residence purchased with the proceeds of the sale of an existing residence. Two or more of the client’s children or other relatives typically serve as co-trustees of the trust, and distributions of trust income can be made to either of such trustees only with the consent of the other co-trustee, thus providing the client with protection against misuse of the trust funds, as well as issues stemming from potential lawsuits or divorce involving either of the trustees. When distributions are made to either of the trustees, the recipient can then apply the distributed funds for the “supplemental needs” of the client (and his or her spouse, if any). The trust instrument is intentionally structured to minimize income taxes, both during the client’s lifetime as well as after his or her death, i.e., to his or her children.
Trusts established upon a client’s death for his or her spouse carry with them much the same drafting aspects as trusts established during the client’s lifetime. The major difference is that some Medicaid rules arguably require that any supplemental needs trust for the benefit of a surviving spouse be established under the client’s “will”; thus special care must be taken in order to avoid potentially offending this requirement. Consideration should likewise be followed when funding these types of trusts with IRA or other qualified retirement plan benefits, and consideration should be given to paying such benefits to children, rather than to a surviving spouse.
A Concluding Example of the "Holistic" Approach
What, if anything, can be achieved through combining the retirement planning, income tax planning, insurance planning and/or estate planning components, to solve the dilemma of the IRA or other qualified plan account described above, while achieving the client’s ultimate objective, which is to preserve the IRA or other qualified retirement plan account to the greatest extent possible, and for as long as possible, for the client as well as for the client’s family after his or her death?
One potentially viable idea would be to make smaller annual withdrawals from the IRA or other qualified plan (approximately equal to the annual growth and income of the same), pay income taxes on the withdrawn amount, and then use the balance of the withdrawal to make annual premium payments on a state partnership plan qualifying long-term care insurance policy having a lifetime long-term care benefit equal to the current value of the IRA or other qualified plan account.
Assume, for example, that a client transfers all of his or her assets away to his or her children, excepting only a $200,000 taxable IRA, which generates approximately $10,000 (or 5%) in annual income and growth. The $10,000 is withdrawn each year and nets the client $7,500 after the payment of federal and state income taxes on the same. If this $7,500 net amount is applied each year towards the annual premium payment on a state partnership plan long-term care insurance policy having a total benefit of $200,000, the $200,000 IRA will not be treated as a resource of the client for Medicaid-qualifying purposes. This situation thus provides an excellent example of the manner in which all four professional disciplines - retirement planning, income tax planning, insurance planning and estate planning - should work together to accomplish the client’s long-term care objectives, in order to provide the client with the greatest possible after-tax source of funds available for his or her long-term care, as well as for his or her family.
©James G. Blase, St. Louis, Missouri 2015
DISCLAIMER: The above article is provided for informational purposes only, and is not intended as legal or tax advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship.