The high costs of long-term care affect an increasing number of individuals and their families. According to Genworth’s 2016 Cost of Care Survey (http://bit.ly/2ngymTT), the average annual cost of an assisted living facility, which provides personal care and health services, was $43,536. The average cost of a semiprivate room in a nursing home, which provides a higher level of supervision and care than an assisted living facility, was $82,125; $92,345 for a private room. The U.S. Department of Health and Human Services has projected that the number of individuals requiring paid long-term care services in 2050 will be double the number in 2000 (“The Future Supply of Long-Term Care Workers in Relation to the Aging Baby Boom Generation,” May 14, 2003, http://bit.ly/2oNfPLV). How can individuals and their families address the high cost of long-term care? This article considers some of the common financial, legal, and tax concerns. This is not meant to be a complete discussion of all issues, but rather an introduction to the many issues that need to be addressed.
What Is Long-term Care?
Medical treatment is designed to cure a condition or illness. Long-term care is different; it is meant to address the needs of an individual who, because of a chronic condition, accident or other trauma, or illness, requires assistance with basic self-care tasks (activities of daily living; ADLs) or other necessary assistance for independent living (instrumental activities of daily living; IADLs).
ADLs include personal hygiene, dressing, eating, continence, and transferring (e.g., getting in and out of bed). IADLs are basic communication skills, transportation, shopping and meal preparation, housework, managing medications, and managing personal finances.
No one knows for sure whether he will ever need long-term care, but increased longevity in the population, family medical history, and other factors suggest that everyone should be thinking about it. Wealthy individuals can personally bear the cost of long-term care, although they too need to plan for financial management and advance medical directives. Those with little savings and income must rely on family, charitable organizations, and government assistance. Those with moderate resources are well advised to plan ahead for the potential financial cost of long-term care.
Long-term care insurance.
Those who can afford the premiums should buy long-term care insurance or explore state-sponsored long-term care partnerships that function like long-term care insurance. Currently most but not all states offer such partnerships. Generally, long-term care insurance pays a fixed daily amount when the insured needs long-term care. The coverage may run for a set period, such as three years, or for the life of the insured.
Premiums for long-term care insurance are treated as deductible for federal income tax purposes as medical expenses, up to set dollar limits [Internal Revenue Code (IRC) section 213(d)(10)]. For 2017, the limits are—
- 40 and younger, $410;
- 40 to 49, $770;
- 50 to 59, $1,530;
- 60 to 69, $4,090; and
- over 70, $5,110.
[Revenue Procedure 2016-55, Internal Revenue Bulletin (IRB) 2016-45, 707.]
These limits are per individual, so if both spouses are 65 years old and each has a policy, the limit on their joint return would be $8,180.
Itemized medical expenses are deductible to the extent they exceed a percentage of adjusted gross income (AGI). For 2017, all taxpayers, including those age 65 and older, the threshold is 10% of AGI [IRC section 213(a)]. Prior to 2017, this threshold was 7.5% of AGI.
If retired public safety officers elect to pay long-term care premiums with tax-free distributions from their qualified retirement plans, they cannot deduct the premiums. This rule applies where the distributions are paid directly to the insurer, but would otherwise be taxable if received by the officers.
Self-employed individuals have a special deduction rule. They can deduct healthcare premiums as an adjustment to gross income rather than itemize, and long-term care premiums (up to the age-based limits) can be treated in the same way [IRC section 162(l)].
Life insurance contracts and commercial annuities can be combined with long-term care coverage (hybrid policies), typically with a rider on a whole life insurance policy or an annuity [IRC section 7701B(e)]. For hybrid policies, none of the premiums are deductible if they are a charge against the cash surrender value of life insurance contracts or cash value of annuities [IRC section 7701B(e)(2)].
If employers pay the cost of long-term care insurance for employees, spouses, dependents, and employees’ children under age 27 by the end of the year, this is treated as a tax-free fringe benefit [IRC section 106]. These premium payments, regardless of cost, are not subject to FICA taxes. When employees leave the company, they may be able to continue the coverage by paying their own premiums.
Funds in health savings accounts (HSA) can be used to pay for long-term care insurance (IRS Publication 969). These HSA distributions are tax-free to the extent of the age-based limits discussed earlier. A medical flexible spending account (FSA) cannot be used to pay premiums on long-term care insurance [IRC section 125(f)].
States may provide different treatment for the payment of long-term care insurance for state income tax purposes. For example, New York residents can claim a tax credit of 20% of the full amount of long-term care premiums (http://on.ny.gov/2nHObhN).
As mentioned earlier, one of the IADLs is managing finances. Without planning, an inability to handle this responsibility may require court intervention for a conservatorship or guardianship, which is costly and potentially embarrassing. Planning ahead allows for the solution that best meets a person’s wishes and financial situation. Selection of the right person to handle financial management is paramount.
One option, the durable power of attorney (POA), allows another person, such as a spouse, adult child, or close friend, to act as the person’s agent for financial matters. It is durable because it continues in effect even when the person becomes incapacitated. Powers granted to the agent can include handling bank accounts and investment decisions, selling real estate, and, for some, gifting (usually limited in the amount and class of individuals who can be recipients). The durable POA cannot authorize the agent to make a will on behalf of the individual.
Some banks and other financial institutions prefer to have individuals use their own POAs. While these institutions can legally be required to accept the individual’s durable POA, it can save time and hassle to have the individual sign the financial institution’s form.
A variation on the durable POA is a springing durable POA. As the name implies, it springs into effect upon the occurrence of a certain event, such as the individual’s becoming unable to handle financial matters. The critical issue with this document is to clearly define the event (typically “incapacity”), as well as how to prove it so that third parties will recognize the effectiveness of the agent. Many planning professionals prefer not to use a springing POA because of the complications of proving that it has sprung, but some clients insist on it.
For individuals who have homes in more than one state, it may be necessary to have POAs in each state. Some states recognize the POAs from another state, but others do not.
Another option is a living trust. While a revocable trust becomes irrevocable upon incapacity of the grantor, a living trust can be better tailored to an individual’s needs. For example, if there is no individual to act as trustee, the person can name a financial institution to do so. A living trust can also act as a will substitute by specifying what happens to assets in the trust upon the death of the grantor. In some states where probate is expensive and lengthy, the use of a living trust is desirable. Either kind of trust can be used in place of or in addition to a durable POA.
Advance medical directives.
If an individual wants to authorize someone to speak on her behalf when she is unable to do so, specific action should be taken. In view of today’s HIPAA laws on patient privacy, it is difficult if not impossible to speak for another person or obtain medical information about that person without a legal document. As with financial management, selecting the right person to act in health care matters is vital.
Like a financial POA, a healthcare POA names someone to make medical decisions. In some states, healthcare powers are incorporated in a financial POA; in others, separate documents are required. Similar in function to a healthcare POA is a healthcare proxy, which designates another person to make medical decisions. These documents can give unlimited powers or restrict decision making as prescribed by the individual.
Living wills describe the type of medical treatment that is (or is not) desired in end-of-life situations. They sometimes include, but can also be separate from, a do not resuscitate (DNR) order. This is a directive to withhold cardiopulmonary resuscitation (CPR) or advanced cardiac life support (ACLS) in the event a person stops breathing or the heart stops beating, allowing the person to die naturally.
Housing and Long-term Care
Many individuals in need of long-term care prefer to stay in their own homes. This is often possible if there is assistance available from a relative or paid caregiver (usually a paid attendant who does no skilled nursing care). According to AARP approximately 40 million Americans are unpaid caregivers for adults, and this number is forecasted to be 45 million by 2020 (“Caregiving Innovation Partners,” January 2017, http://bit.ly/2p5S1lM). Relatives who fill this role may need their own respite care to take time off from the emotional and physical demands of daily caregiving. At present, there is no tax break for this type of respite care.
The cost of in-home care may be covered by a long-term care policy. There may be other payment options, including an attendant allowance through the Veterans Administration for veterans and their spouses. An attendant may be hired by the family or sent from an agency. In the first situation, the family must ensure that employment tax obligations are met, as explained in IRS Publication 926 (http://bit.ly/2o1DVTc). With the second option, there is an hourly fee paid to the agency, which may be a deductible medical expense (see below). According to the Genworth survey referenced above, in 2016, the average fee paid to a licensed agency for a home health aide to provide personal but not medical care was $20 per hour.
If care cannot be provided in the person’s home, there is a spectrum of care provided in different arrangements, ranging from independent living to assisted living, skilled nursing care, and intensive nursing home care. The cost of living in a nursing home, which is used primarily for medical reasons, is a deductible medical expense to the extent the care is not covered by insurance or a government program. No allocation is needed for medical services; all of the costs, including amounts for food and lodging, are deductible.
Those residing in continuing care facilities in order to receive long-term assistance may also claim a deduction, but only for a portion of their costs. If, however, this living arrangement is primarily for personal reasons and not primarily for medical care, then only costs related to medical care are deductible. This can be based on the percentage of costs allocated to medical care [see, e.g., Revenue Ruling 67-185, 1967-1 CB 70; Revenue Ruling 75-302, 1975-2 CB 86; Revenue Ruling 76-481, 1976-2 CB 82, and Baker v. Comm’r, 122 TC 143 (2004)].
Paying Out-of-Pocket for Long-term Care
Even though long-term care is not medical treatment, the costs for qualified long-term care services of a chronically ill individual that are not covered by insurance, government benefits, or other sources can be treated as a deductible medical expense (IRS Publication 502). For example, in one case an individual suffering from dementia required round-the-clock supervision because of her diminished capacity. The Tax Court allowed the cost of this care to be a deductible medical expense because her need was certified by her doctor, a licensed health-care professional [Est. of Baral v. Comm’r, 137 TC 1 (2011)].
Tapping Long-term Care Policies
When it is medically determined that the insured needs long-term care, a long-term care policy begins to pay off after an elimination period, such as 30 or 90 days. If the policy pays a per diem amount without regard to the insured’s costs, only the portion up to a set dollar limit is tax-free. This amount is $360 per day for 2017 (Revenue Procedure 2016-55, IRB 2016-45, 707).
If the policy has a higher per diem amount, however, it can be tax-free to the extent of the actual cost of qualified long-term care services for a chronically ill individual. Qualified long-term care services are defined as necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative, and maintenance and personal care services for a chronically ill individual under a plan of care prescribed by a health-care practitioner. A chronically ill individual is someone who, within the previous 12 months, has been certified as being either of the following:
- Unable to perform at least two ADLs without substantial assistance for at least 90 days because of a loss of functional capacity. ADLs are eating, toileting, transferring, bathing, dressing, and continence.
- Requiring substantial supervision to be protected from threats to health and safety due to severe cognitive impairment.
Proceeds from life insurance policies.
A life insurance policy may permit the payment of accelerated death benefits to the insured when he becomes chronically or terminally ill; these benefits can be tax-free [IRC section 101(g)]. Tax-free treatment applies to all proceeds payable on account of a terminal illness (i.e., one expected to result in death within 24 months, with some exceptions). Tax-free treatment on account of chronic illness is limited to the amount described earlier for long-term care insurance proceeds.
Those who need to raise funds may sell their policies in a viatical settlement. The proceeds from such a sale are tax-free [IRC section 101(g)(2)].
Helping Clients Prepare
The matter of long-term care is a complicated issue involving not only personal considerations but also legal, financial, and tax concerns. It is essential that financial professionals help individuals understand the myriad aspects of long-term care and meet the challenges that arise.
LONG-TERM CARE PLANNING CHECKLIST
- _____ Do I need long-term care insurance?
- _____ Do I have a durable power of attorney?
- _____ Do I need a living trust?
- _____ Do I have advance medical directives?
- _____ Have I considered my living arrangements if I become incapacitated?