We had a sad situation with one of our clients recently. He was just entering his golden years when he learned that he had a serious illness, the kind that would require around-the-clock medical care. He had a large retirement fund and was interested in a number of options for covering his medical expenses, either through paying out-of-pocket through his IRA or through a policy that might be difficult to get approved given his condition. However, when we did the math, we realized the best possible option for him was a single premium immediate annuity (SPIA).
The Good and the Bad of Disability and Long-Term Care Insurance Policies
Typically, you can get long-term care/chronic care and disability insurance two ways. You can either buy a standalone policy, which you would use in the event you become disabled or need long-term care. Or, you can add a long-term care or disability rider to an existing insurance policy, like life insurance or an annuity. In these cases, you bought the policy for something else, but in the event you develop a debilitating illness, a special provision will kick in allowing you to get increased payments to cover medical care.
Here’s the issue you’re going to run into with these types of policies. Usually, the only time you can get them is before you’ve developed an illness. Trying to buy a long-term care policy after you find out you’re seriously ill is like trying to buy a life insurance policy when you have a terminal illness. It just won’t work and if it does, your premiums are going to be astronomical.
While long-term care and disability policies can be a great option, they only work if you buy them before you need them. Now, at this point, someone might think that they’ll need to pay out-of-pocket to get the necessary care. Unfortunately, that can deplete an account pretty quickly if you’re pulling from an IRA.
Paying Out-of-Pocket with an IRA
The other option the sick client was thinking about was taking direct withdrawals from his IRA as a means of covering his medical care. Now, he had a reasonably big IRA, but even then, we warned him off that tactic. No matter how big an IRA you have, the funds within one are finite and the tax burden associated with distributions is costly. With expensive medical treatment, it’s possible to run out millions of dollars in only a few years.
Consider the case of hiring a home health aide. A qualified aide will cost about $21 per hour, so a full-time day nurse will cost $840 a week, coming in at a total cost of about $44,000 per year. That’s only the cost of a day nurse and doesn’t account for night shift nurses, hospital stays, medication, doctor appointments, and any other recommended treatments. While some of that will be covered by health insurance, keep in mind that health insurance has its limits and doesn’t cover anything.
Also, you can’t just sit on the IRA funds to save them when you don’t need them. After the age of 72 you must start taking required minimum distributions (RMD). Even if you withdraw way more than you have to in one year, you can’t carry that amount forward to satisfy future RMDs. So, you can’t just save the money in the account for when you need it for medical care. You must withdraw it, even if you don’t need it.
Now, don’t get me wrong. An IRA can be useful for managing your medical care in the future. But the best way to use it isn’t to withdraw directly from the account. For many, the best option is to roll it into a SPIA.
Using an IRA to Fund a Single Premium Immediate Annuity
You can use funds within your IRA to purchase a SPIA without getting hit by a huge tax bill. Doing this within your IRA is considered a qualified rollover and not a cash out, so you will only have to pay taxes on the installment payments you receive. Those payments will be taxed at an ordinary income rate. In addition, the SPIA distributions offer a cash flow as high as 8 to 10 percent annually for life of the invested amount depending on age and the options chosen.
The key is that the SPIA offers a few benefits over taking withdrawals from your IRA. First, the annuity payment is based on your life expectancy, but it has an inverse relationship to that life expectancy. With annuities, the shorter your life expectancy, the higher your payment. So if you have a long-term illness that requires regular care, you’re going to get higher installment payments.
Next, the lifetime amount paid out is unlimited. The insurance company may offer you payments with the belief that you will die within the next five years, but if you beat the odds and live another 20, those payments don’t stop. They keep going for the rest of your life. It’s entirely possible that the payments you receive from a SPIA will exceed the premium you paid in several times over. Finally, that SPIA will eliminate the need to worry about RMDs because the annuity will be paying out money from that account on an ongoing basis, which will satisfy the RMD requirement.
A SPIA is often the best option we can think of when we’re trying to ensure that an uninsured client who needs long-term medical care is covered. These SPIAs can cover years of expenses by being funded with one lump payment and can keep you in a tax-friendly position. For more information on using a SPIA to cover ongoing medical care, contact a Howard Kaye advisor today at 800-DIE-RICH.
