In the mid-1990s, my client Irma Kaye (not her real name) and her son reviewed various long term care insurance options and benefit choices. Her story demonstrates the value of comprehensive LTC insurance, when it’s affordable.
At the time, Irma was healthy, busy with her social life and enjoying her independence. The accepted protocol then was to select a daily benefit slightly over the average cost of care, skip inflation and cover a couple years of care. Mother and son debated costs and coverage, settled on a 3-year benefit, and then called during underwriting to expand to unlimited with 5% simple inflation.
She later went on claim. In addition to receiving substantial insurance benefits, Irma has been able to choose high quality care close to her family. Moreover, she has maintained her considerable dignity, knowing she has not consumed assets planned for her family or been forced to rely on Medicaid LTC welfare programs.
In fact, her LTC benefits starting at $90 a day have evolved into a $500,000 claim over a 12-year period–and a total insurance benefit of $750,000.
How did this happen? By recognizing that taxes on liquidated investments spent on care, and loss of investment opportunity on those funds, add to the care cost and to value of each dollar paid in claims. Specialized software helps compute this outcome.
Consider: Most people cannot pay $500,000 without dipping into retirement or other investment funds. Liquidation of these investments typically is a taxable event and may be quite expensive. For example, each dollar distributed from a qualified retirement plan is taxed at the client’s marginal tax rate. Federal and state taxes combined could be as high as 35% to 40%. In other words, for each dollar withdrawn to pay the cost of care, it will cost another 35 cents to 40 cents to pay taxes on the withdrawal.
Some advisors discount the value of LTC insurance, suggesting the client could tax deduct uninsured care costs. This is true, but the numbers tell a more accurate story. The tax deduction is limited to dollars above 7.5% adjusted gross income. Also, retired individuals typically take the standard deduction, which is lost if filing the long income tax form in order to deduct cost of care. The net effect, in most circumstances, is the tax cost of liquidating investments is greater than the tax deductions for uninsured care costs.
The income loss on investments used to pay care costs is the second multiplier making a care dollar more expensive and claim dollars more valuable than a dollar. The tax and investment loss would have expanded Irma’s care cost, if uninsured, from $500,000 by an additional $250,000 impact on family wealth.