Long-term health care costs can be reduced

March 03--Costs associated with long-term care that might be needed by a loved one can strain family finances.

The burden of those costs can be reduced for those who purchase a long-term care insurance plan. But premiums for such coverage often seem out of reach for middle-income families.

Financial advisers, however, say there are ways for those who plan ahead to use tax-deferred income stashed away in retirement plans to pay the premiums for qualified LTCIs. When done properly -- of course, one should consult with a financial adviser or tax lawyer -- LTCI premiums can be paid with tax-free funds in some instances and with retirement funds later as a means to avoid tax penalties associated mandatory age-related withdrawals.

The American Institute of CPAs, on its website dedicated to promoting financial literacy, offered three ideas about how to pay LTCI premiums with tax-free funds. Using a health savings account, which the institute defines as "a tax-advantaged savings account tied to a high-deductible health insurance health plan," is the first suggested option.

HSAs are funded with pretax contributions -- those contributions are subject to annual limits set from time to time by the Internal Revenue Service. Taxes are deferred for any growth, and HSA funds that remain unspent during any year may be carried over to subsequent years.

"Just as importantly, withdrawals made from your HSA for qualified medical expenses are tax free," personal finance experts with the AICPA say. "Tax-qualified LTCI premiums are a qualified medical expense eligible to be paid from HSA funds, (but) the maximum annual premium you can pay tax free is subject to long-term care premium deduction limits."

Two other options available to those looking for ways to pay LTCI premiums with tax-free funds include programs authorized by the Pension Protection Act. One, the AICPA reports, is available through a program available to qualifying retired public safety officers, and the other "extends the tax-free exchange of annuities for qualified standalone LTCI or combination annuity-LTCI policy."

The Healthcare Enhancement for Local Public Safety Retirees Act, authorized by the Pension Protection Act of 2006, allows qualified public-safety officers who are retired to withdraw funds from a retirement plan tax-free when that money is used to pay LTCI premiums for themselves and eligible dependents. Eligibility is contingent upon a number of factors, which include things such as public-safety officer types and the retirement plans from which funds would be drawn and used.

Converting what generally would be considered a taxable annuity to a tax-free LTCI is a third option. But AICPA experts warn of "some potential drawbacks" that should be considered.

"Generally, withdrawals from a non-qualified deferred annuity -- premiums paid with after-tax dollars -- are considered to come first from earnings, then from your investment -- premiums paid -- in the contract," AICPA reports in an article on its financial literacy website. "The earnings portion of the withdrawal is treated as income to the annuity owner, subject to ordinary income taxes."

One section of the tax code, however, authorizes an "exchange of one annuity for another without any immediate tax consequences as long as certain requirements are met." That provision of the tax code extends the tax-free exchange of annuities "for qualified stand-alone LTCI or combination annuity/LTCI policies."

The potential drawbacks include the possibility that one may incur what is known as "annuity surrender charges" when the transfer occurs, and there could be a loss of potential income from the annuity. A person who takes advantage of this option also loses some of the advantages of certain costs, like qualified medical expenses and LTCI premiums, being tax deductible.

For those who are nearing the age of 70 and have tax-deferred income parked in a 401(k) or individual retirement account, there are mandatory withdrawal rules in place accompanied by hefty penalties for noncompliance. Alexander Joyce, president and CEO of ReJoyce Financial, said moving retirement funds to an asset-based long-term healthcare program can protect retirees from these fees.

"These are tax-deferred accounts, so people are able to avoid paying taxes on the income they contribute to them, but that's true only for awhile," Joyce said in a media release. "The money is taxed when you withdraw it, and when you turn 70 1/2 -- even if you would like all the money to stay where it is -- you have no choice but to begin taking money out of it."

Joyce said he began recommending the asset-based long-term healthcare to his clients about three years ago, when it became clear there were many baby-boomers who might need some additional information to help them avoid these penalties. In addition to avoiding penalties, Joyce said this strategy provides the benefits of being "an interest-bearing account that provides income ..., liquidity ... and covers long-term health care if needed."

"I foresaw the problems that they were going to have with their retirement accounts when they turned 70 1/2 ," Joyce said. "Some people plan to take out money anyway to live on, but many others have no interest in taking any distribution from their accounts."

Joyce said anyone who has money in a 401(k) or IRA must "know the rules and what they will be facing." He recommended they visit with a financial professional about all options available sooner rather than later.

Reach D.E. Smoot at (918) 684-2901 or [email protected].

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