Long Term Care Strategies

Posted on August 18th, 2010 in Health Care, Newsletter Articles, Retirement Planning, Risk Management by wayne

In 2011, the leading edge of the “Baby Boomer” generation reaches age 65, while the average American life span continues to rise.  The confluence of these two phenomena will dramatically increase the number of Americans who will ultimately require long term care.  With the national average annual cost of nursing home care exceeding $78,000, many are considering how to fund long term care (LTC).  Let’s look at some strategies for funding potential LTC requirements.

Long Term Care insurance typically pays a maximum daily amount for either in home care or nursing home care, after an elimination (waiting) period of either 90 or 180 days.  LTC insurance policies are a popular method of protecting against catastrophic long term care expenses.  However, depending upon the age at which you initiate the LTC insurance, policies will often have premium costs between $2,000 – $6,000 annually.  Like any insurance policy, these payments could be very worthwhile if LTC is required, but are lost if LTC is never needed.

Beginning in 2010, the 2006 Pension Protection Act provides new methods in which LTC insurance can be funded.  Some “hybrid” whole life insurance policies are combined with LTC coverage.  With these policies, a portion of the death benefit can be paid out before death, to cover the insured’s LTC expenses.  “Hybrid” deferred fixed annuities can also be packaged with LTC benefits.  Starting this year, any LTC benefits that are received from either of these “hybrid” products are tax free, providing considerably higher after tax benefits for most recipients.

A current whole life insurance policy or deferred annuity may also be utilized when purchasing a new “hybrid” policy, through a nontaxable exchange under IRC Section 1035.  If the “hybrid” product insurer provides for a 1035 exchange, you may “convert” a current life insurance or annuity policy to a “hybrid” policy.  The “hybrid” policy will allow for  insurance proceeds, used to pay for long term care, to be received on a tax free basis.

Another way to pay for long term care is to “self insure.”  Insurance products are best when used to protect against financially catastrophic events.  If you have adequate financial resources, you may wish “self insure” for long term care requirements.  Let’s see how self insurance works.

Jane is a single 85 year old, with $300K in retirement funds and other investments.  She also owns a mortgage free home valued at $300K.  To meet her current annual expenses of $45K, she withdraws $25K per year from her investment portfolio.

At the end of 2010, Jane, no longer able to care for herself, enters a nursing home, at a cost of $80K/year. Upon entering nursing home care, Jane’s other annual expenses decrease to $5K.  In 2011, Jane’s annual expenses will be $85K, requiring her to withdraw $65K per year from her investment funds.

Assuming no investment growth, Jane’s funds would be depleted in 2015, when Jane is age 90.  However, Jane (or possibly her children) can use a reverse mortgage or an outright sale of her home to provide more funding for her Long Term Care.  In this scenario, Jane will likely never outlive her financial resources.

When considering “self insurance”, remember that the cost of nursing home care is offset by a significant reduction in current expenses.  It is also important to consider the value of a home and other non-liquid, but salable assets in determining if self insurance is right for you.

Long Term Care requirements will affect many baby boomers.  If you are a member of this generation, now is the time to determine what financial strategies meet your LTC requirements.

New Taxes on the “Wealthy” – Is This You?

Posted on July 19th, 2010 in Health Care, Newsletter Articles, Taxes by wayne

The health care bill, enacted in March, includes two new Medicare taxes on the “wealthy.’  While you may not consider yourself wealthy, there is a reasonable chance that you may have the opportunity to pay one or both of these taxes.  Let’s examine these new Medicare taxes to determine if they might be part of your financial future.

The first tax is a 62% increase (from 1.45% to 2.35%) in Medicare taxes for individuals with earned income over $200K and for couples with earned income over $250K.  While a single person earning over $200K per year is highly compensated, couples need only earn more than $125K each to be engulfed by this new tax.  As usual, the minimum earnings amount is not tied to inflation.  If 1970s style inflation appears in the next few years, earnings of over $125K may become much more common.

The second Medicare tax on the “wealthy” is a 3.8% tax on investment income for singles with an Adjusted Gross Income (AGI) exceeding $200,000 and couples with an AGI exceeding $250,000.   Let’s look at a scenario in which a couple whose earnings are less than $250K could end up paying almost $75K for this new tax.

You and your spouse are 60 years old and owners of a small Sub Chapter S Corporation.  Your joint salaries total $175K.  Through diligent saving over the past 35 years and a small inheritance, you have $1 million dollars in investments to help provide for a reasonable standard of living in your retirement years.

In 2013, the economy finally begins to recover and your business booms, throwing off $75K in dividend income.  At the same time, the stock market finally recovers and you have a 15% return on your investments.

Your AGI from salary and company dividends in 2013 is $250K.  Because of this “wealth,” the $150K in investment income from your savings would be taxed at the then current income tax rate plus you would pay an additional $5,700 in Medicare taxes.

After paying these high taxes in 2013, you decide to sell your business and retire in 2014.  The business sells at the end of 2014 for $1 million.  In 2014 your salaries and dividends from the business total $200K and your investments provide an 8.7% return of $100K .

For 2014, your AGI from salary and company dividends in 2013 is $200K, while your total investment gains (including the sale of your company) are $1.1 million.  The new 3.8% Medicare tax on the “wealthy” would cost you an additional $39,900 above your already high 2014 taxes.

In 2015, you decide to downsize your house, built in 1975 at a cost of $40,000, as well as sell your ski condo that you bought in 1980 for $60K.  Living in Boulder, your house sells for $940K and your condo sells for $460K.  While you have $0 earned income, your investment portfolio increases by approximately 10%, providing $200K in investment income.  Even with the $500K capital gains exclusion for the sale of your home, your total taxable investment income in 2015 is $1 million.  Since $750K of the investment income is taxed at the additional 3.8% rate, the new Medicare tax adds $28,500 to your 2015 tax bill.

The small business owners in the above scenario would hardly be considered “wealthy.”  However, in three years, this couple could pay $74,100 in additional Medicare taxes, thanks to health care reform.

There are several ways that this couple could reduce their taxes, but they did not even know about these new Medicare taxes.  As our government needs more and more tax revenue to sustain its profligate spending, tax planning becomes even more critical.

The good news is that these new taxes do not become effective until 2013.  If you are planning on selling your business or home, tax planning now could save you thousands of dollars in taxes later.  Now, more than ever, it is important to do advanced tax planning with a financial professional who fully understands the tax system.  As our example shows, not understanding the new tax laws can be very expensive.

Choose the High Deductible Health Plan

Posted on September 26th, 2007 in Health Care by wayne

Many companies are now offering the choice of a “traditional” health care plan or a high deductible health plan (HDHP). Often, the employees are only told that the HDHP costs less (usually by 20% – 30%) and has a higher deductible. The deductible for a family “traditional” plan is often at least $500 per individual and $1,000 for the family. For a HDHP the family deductible is often as much as $3,000.

If your traditional plan costs $200 per month and the HDHP costs $160 per month (20% less) you might be believe that the $40 per month ($480 per year) savings is not worth the risk of possibly paying $2,000 more in deductible expenses. This could be true, if you do not take advantage of the tax free Health Savings Account (HSA) that can be matched with the HDHP.

However, if you are in at least the 25% federal income tax bracket and deposit the family policy maximum of $5,650 into your HSA, the cost of an HDHP will always be less than a the cost of using a traditional plan. If you are in the 25% federal tax bracket, the $5,650 HSA deposit will provide a federal income tax savings of ($5,650 *25%) = $1,412.50.

Next, using your HSA for medical expenses lets you pay for them with tax-free dollars. The $3,000 deductible can be paid with these tax-free funds. This reduces the $3,000 cost by your 25% tax bracket to a cost of $2,250 on an after tax basis.

Let’s add up the after tax costs of each plan. The traditional plan costs $480 more and saves you ($2,250 – $1,000) = $1,250 on after tax deductible costs, for a net “savings” of ($1,250 – $480) = $800

However, the HSA deposit of $5,650 has an income tax saving of $1,412.50. When the income tax savings is included, the HDHP plan costs ($1,412.50 – $800) = $612.50 less than the “traditional plan, even when your health care costs “max” out the $3,000 deductible.

If you only use $1,000 in medical expenses for the year, the savings with the HDHP is $2,142.50. This represents the sum of the insurance savings ($480), the HSA tax savings ($1412.50) and the savings from paying the deductible with funds that are never taxed ($250).

If you are in a higher tax bracket and/or if you pay state income taxes, your savings with an HDHP are even greater. Plus, the funds remaining in the HSA continue to grow tax free and can be used for future medical expenses tax free.

The bottom line is that, if you are in at least the 25% federal income tax bracket and your company offers an HDHP, you will always come out ahead with the HDHP, as long as you contribute the maximum amount allowed to your HSA.

Fund Your HSA with Your IRA

Posted on September 14th, 2007 in Health Care by wayne

As discussed in the Financial Abundance Guide, if your marginal federal income tax rate is 25 percent or higher, on an after tax basis, you will save money with a High Deductible Health Plan (HDHP), when you fully fund your Health Savings Account (HSA).  In 2007, if you are single and your Adjusted Gross Income (AGI) is over $31,850 or filing jointly with an AGI over $63,700, an HDHP/HSA combination will save you money, as long as you fully fund your HSA.

For many people, the ability to fully fund their HSA may be a challenge. “Fully funding” requires that a single person deposit $2,850 or that a family deposit $5,650 into an HSA.  To help solve this problem, the Tax Relief and Health Care Act of 2006 allows you to do a one-time funding of your HSA by rolling over IRA funds into your HSA.

This rollover is similar to doing an IRA to Roth IRA conversion. However, with an HSA rollover, you are not required to pay taxes on the funds transferred to your HSA (as long as you maintain your HDHP for at least 12 months).  Like a Roth IRA, all HSA funds grow on a tax free basis and can be withdrawn tax-free, as long as the funds are used to pay for health care related expenses.

Another one time funding source for your HSA is a rollover from an employer-sponsored flexible spending account (FSA) or health reimbursement account (HRA).  Your rollover is limited to the account balance on the date of transfer or on September 21, 2006, whichever is less.  The rollover must also be made before January 1, 2012.  If your yearly FSA contributions will not be consumed, this approach may keep you from losing the remaining FSA funds.

If you have a High Deducible Health Plan (HDHP), fully fund your Health Savings Account (HSA).  By doing this, your total after-tax health care costs are virtually guaranteed to be lower than they would be with a comparable “low deductible” health care plan.