As the Baby Boomers age, the practice of elder law is changing. One significant change is a result of how the Baby Boomers invest their assets.
The Greatest Generation—the generation who were young adults during World War II and who are the parents of the Baby Boomers—did not invest the bulk of their wealth in retirement accounts, such as 401(k)s and individual retirement accounts (IRAs). Many of the Greatest Generation subsist on a defined pension benefit and Social Security income. While they may have IRAs, the value of the accounts tend to be relatively low.
Baby Boomers, on the other hand, tend to have a significant amount of wealth invested in IRAs and other qualified accounts. While many Baby Boomers do have defined pension benefits, as well, true pension plans were slowly dying out during their adulthood. They rely more and more on their retirement accounts.
Retirement accounts present unique issues. Fundamentally, the issue with retirement accounts is that when the owner of the account removes money from the retirement account, the withdrawal is taxable income.
So, if Mr. Smith has an IRA worth $400,000 and he removes $400,000 from his IRA, he would have $400,000 of income in that year and would have to pay tax on that $400,000 of income. This causes issues when people want to qualify for Medicaid or when they want to leave their retirement accounts to their heirs after their death.
Let’s assume that Mr. Smith enters a nursing home costing $12,000 a month. He wants to qualify for Medicaid benefits, so the Medicaid program will pay for his nursing home stay.
There are a number of techniques that I can employ in order to qualify Mr. Smith for Medicaid benefits, but one of the biggest issues in the planning will be the fact that in order to implement any of these techniques, Mr. Smith will need to remove the assets from his IRA.
When Mr. Smith removes the $400,000 from his IRA, he will have $400,000 of income. Mr. Smith will have to pay income tax on an additional $400,000 of income. While he may have some deductible medical expenses to write-off against the $400,000 of income—his nursing home bill for that year—he still has a tremendous amount of income in one year.
If long-term care is a serious concern of yours, you might want to consider removing money from retirement accounts that you own quicker than is required in order to spread the income over several years. A person has to take a minimum distribution amount from his retirement accounts every year after he attains the age of seventy and a half. The amount is typically referred to as the Required Minimum Distribution Amount or RMD.
The RMD is a small fraction of the retirement plan, approximately 1/26th every year. The owner of the retirement account can take more than the RMD in any one year, but he must take at least the RMD.
Retirement accounts can play an important role in long-term care planning, particularly when Medicaid eligibility is a concern. Understanding how withdrawals affect taxable income and planning ahead can help avoid unnecessary tax consequences.