Money contributed to the Thrift Savings Plan (TSP) and IRAs grows tax-deferred, or tax-free in the Roth TSP and in Roth IRAs, in order to hopefully generate sufficient income for a federal employee’s retirement years.
While federal retirees would prefer to spend their retirement income on pursuits that make their hearts content, they should be aware that they must also expend money on their physical maintenance, especially when they reach their late 70’s and early 80’s. Healthcare is the third most significant ‘unsystematic” retirement risk. It is considered “unsystematic” because healthcare occurrences are random and vary among individuals.
This column focuses on a specific type of healthcare-related unsystematic risk – namely, long-term care (LTC) or extended care. This type of care requires assistance over a prolonged period to perform certain activities of daily living, includes, eating, bathing, dressing and transferring in and out of bed.
LTC is also needed for individuals who have cognitive disorders including dementia and Alzheimer’s disease. The uncapped liability from runaway LTC expenses can severely impact a federal employee’s financial plan for retirement by consuming a federal annuitant’s assets dutifully saved for retirement. These assets include an annuitant’s CSRS or FERS annuity, TSP and Social Security benefits.
The Cost of Long Term Care
The estimated cost of LTC will vary by:
(1) the region of the country in which LTC expenses are incurred; and
(2) the setting in which the LTC is performed. Genworth, a private insurance company that has sold over the years millions of individual LTC insurance policies, calculated the 2020 national median annual charges for in-home LTC to be $54,000, while the national median annual charges for a private room stay in a nursing home can be $105,000. Facility costs vary by locations, reflecting the local cost of real estate and have consistently increased at a greater pace than the Consumer Price Index for Urban Workers (CPI-U). The CPI-U is used to determine the annual cost-of-living adjustments (COLAS) for CSRS and FERS annuitants and Social Security recipients.
Federal government data shows that on average men and women have need LTC for 2.2 years and 2.7 years, respectively. Furthermore, 20 percent of 65-year-olds today may need LTC service for longer than five years.
Where Will the Money Come from to Help Pay for LTC?
The Investment Company Institute believes that the money to pay for future LTC expenses is somewhere in a five-layer “retirement resource pyramid”. While federal annuitants will hold these assets in varying degrees, the financing sources, starting from the base and moving up, are:
(1) CSRS or FERS annuities and Social Security monthly retirement benefits;
(2) homeownership equity;
(3) Thrift Savings Plan (TSP);
(4) IRAs and Health Savings Accounts (HSAs); and
(5) other assets including long-term care insurance and general savings.
If LTC is “suddenly needed” as it frequently happens, CSRS and FERS annuities and Social Security may be committed to pay other living expenses, particularly if there is a spouse who remains in the home or apartment and the mortgage or rent, utilities and maintenance expenses have to be paid with the CSRS/FERS annuity monthly check, and/or with the monthly Social Security check. Home equity may not be sufficient or readily accessible.
Federal annuitants may therefore need to make withdrawals from their TSP and IRAs to pay for their LTC expenses. Those federal annuitants who were enrolled in a high-deductible health plan associated with HSA can make tax-free withdrawals from their HSAs not only to pay for LTC expenses, but also to pay LTC insurance premiums.
But withdrawals from traditional TSP and traditional IRAs are taxable and therefore will increase taxable income. Assuming an individual is in a 22 percent federal marginal tax rate and an 8 percent state income tax marginal tax rate, every $1 in traditional TSP/traditional IRA withdrawals would therefore net 70 cents. For those itemizing deductions, the medical expenses/deduction (if sufficiently large enough) could offset some of the taxable income.
An alternative to making taxable withdrawals from one’s traditional TSP and/or traditional IRA accounts would be to make tax-free qualified withdrawals from the Roth TSP and/or Roth IRA. The problem with making tax-free withdrawals from the Roth TSP and/or Roth IRAs is that once withdrawn, the Roth TSP and Roth IRA assets are no longer growing tax-free over time.
Given the fact that it appears less likely to avoid steep LTC expenses as individuals age, it is important to suggest a way to reduce the risk of depleting of one’s retirement-oriented savings to pay for LTC costs. The U.S. Department of Health and Human Services reports that an individual turning age 56 today has a 70 percent chance of one day needing some form of LTC. One way of minimizing this risk is by purchasing LTC insurance.
The problem with purchasing LTC insurance is twofold, namely:
(1) an individual has to qualify for it. There is no guarantee an individual can qualify depending on their health status; and
(2) LTC insurance premiums can be expensive, especially if an individual buys LTC insurance after age 60.
There are not many insurance companies that offer LTC insurance and the ones that do sell it have increased their premiums significantly in recent years. This includes the Federal Long Term Care Insurance Program (FLTCIP). Information may be obtained at www.ltcfeds.com.
Possible alternatives to LTC insurance are a cash value life insurance policy with a “LTC rider”, as detailed in Internal Revenue Code Section 7702B and those life insurance policies that contain a chronic illness rider, as detailed in Internal Revenue Section Code 101(g). The advantage of these policies is that when the insured dies, there is a death benefit paid out to designated beneficiaries. In addition, both the 7702B and the 101(g) policy offer temporary coverage.
For example, being incapacitated after a knee replacement and having to go to an assisted living facility to recuperate and having a temporary need for LTC. Note that a 7702B policy must provide specific consumer protections. A 101(g) policy cannot use the term “long-term care” in its marketing. However, a 101(g) policy may allow terminally ill or chronically ill individuals to accelerate a portion of the death benefit.
For many federal employees and annuitants, the problem is whether they can afford and will continue to be able to afford to pay the premiums of any of these insurance policies, whether a policy is a pure LTC insurance policy or is a “hybrid” policy (combination of LTC and life insurance). Using withdrawals from one’s TSP and IRAs may allow an annuitant to afford the premiums. With the more flexible TSP withdrawals that have been in place for nearly two years, TSP participants are able to increase their withdrawals more frequently. In addition, the recent surge in the stock market has resulted in significant increases in TSP account balances. In that sense, there are some TSP participants who may be able to “self-insure” by using TSP accounts as their way of paying for possible TC expenses, and not buy any type of LTC insurance.
One advantage of “self-insuring” (by using part of one’s TSP and/or traditional IRA accounts and HSAs) rather than purchasing LTC insurance is that if the TSP participant dies, anything left in the TSP account will go to designated TSP beneficiaries. When buying a “pure” LTC insurance policy (including the FLTCIP) is that if the insured never incurs a need for any type of LTC, or dies before incurring a need for LTC, there is no refund of insurance premiums paid. Another advantage of “self-insuring” rather than purchasing LTC insurance is that an individual does not have to submit LTC claims to the insurance company for reimbursement of LTC expense claims. Some of these LTC expense claims may be rejected by the insurance company as a result of the insured’s expense claims – in the opinion of the insurance company – as not a “legitimate” LTC expense.