Introduction
Want tax advantaged retirement with Roth benefits but are concerned about high long term care costs? You’re not alone. Traditional Roth conversions have tax free withdrawals but do not answer the question of possible health needs later on. This article examines a different solution one that provides the benefits of Roth conversion and the protection of long term care to truly be at peace regarding retirement years and future health.
Roth Conversion Benefits
Roth Advantage
Many individuals have a goal for retirement that is financed with a Roth IRA and meaning that in retirement these dollars are tax free. While other IRAs are tax free on the front end and grow and distribute tax deferred in retirement and a Roth is taxed upfront but grows and distributes tax free in retirement.
Long Term Care Challenge
A sizable threat to many retirees however and is that at some time in their lives LTC services will be needed. These can be extremely costly and will rapidly reduce retirement assets.
The Trade Off
They are caught between a rock and a hard place. They want the tax benefits of a Roth IRA but they don’t want to convert because they might use up money that is necessary for long term care in the future.
Proposed Alternative
The Roth Conversion Alternative is a hybrid approach that links traditional Roth conversions to long term care planning. Here’s how it works
Leveraging Life Insurance
Instead of directly converting to a Roth IRA and an RCA involves converting traditional IRA money to a form of life insurance such as an indexed universal life or a whole life with a chronic illness rider.
Tax Advantaged Growth
These life insurance policies allow for tax advantaged growth of the converted amount and like that of a Roth IRA. Over time it builds up a cash value that can be a potential source of funds for retirement or long term care.
Benefits from a Long Term Care Rider
What really creates all the difference in an RCA is a chronic illness rider. That is to say and this element allows one to gain early death benefit upon diagnosis of a qualified chronic illness. The access to part of the funds early is quite convenient in long term care expenses that won’t blow your retirement savings.
Solve the Problem
It looks to solve this dilemma by offering the tax benefits of a Roth conversion and that is tax free growth and withdrawals and with the possibility of protection against long term care expenses through a chronic illness rider.
What’s the Mechanism?
The mechanics of the RCA entail a few critical steps
Eligibility and Qualification
Age and Health
You need to fall within the age limit allowable by the chosen life insurance policy and also pass the minimum health standards.
Choice of the Life Insurance Policy
Type of Policy
Permanent life insurance policies and more often than not an universal life and or IULwhole life with chronic illness rider are used in an RCA.
IULs have potential growth that is indexed to a market index. Whole life offers guaranteed growth.
Benefits
Make certain there is a chronic illness rider on the policy providing for early access to the death benefit for qualified LTC needs.
Premium Payment
Pay premium out of pocket to keep the policy and rider inforce or use a portion of the converted funds to pay initial premiums.
Roth Conversion Process
Tax Implications
Income taxes are due on the amount converted from your traditional IRA.
Conversion Amount
An appropriate amount to be converted will be based on your tax situation and your retirement objectives and the long term care protection you need.
Life Insurance Policy Management
Growth of Cash Value
The money that is transferred as a result of the conversion becomes the cash value of the policy and grows tax deferred.
Payment of Premiums
Continue to pay premiums as chosen and or allow the growth of the cash value to pay premiums.
Death Benefit
The original death benefit is maintained to be able to leave a legacy for your loved ones.
Long Term Care Benefits
Chronic Illness Rider
This rider stipulates that when you have been diagnosed with a qualified chronic illness and part of the death benefit may be accessed.
LTC Expense Coverage
You can draw on these funds to pay for long term care services without dipping into your retirement savings or relying strictly on traditional long term care insurance.
Tax Implications
Withdrawals from the chronic illness rider may have implications under the policy and rider specifications.
Roth Conversion Alternative ?
The RCA offers several advantages over traditional Roth conversions and standalone and long term care insurance
Combination of Tax Benefits
Tax Free Growth
Much like a Roth IRA and the RCA offers tax advantaged growth in the cash value within a life insurance policy.
Tax free access to cash value
When properly designed and based on the type of withdrawal strategy you would have tax free access to some or all your cash value at retirement.
Chronic illness coverage
The chronic illness rider pays for long term care. It reduces health expenses and preserves retirement assets.
Flexibility and Control
Cash Value Accessibility
Unlike traditional long term care insurance you have access to the cash value in the life insurance policy should you not need long term care for a variety of uses in retirement. It maintains a death benefit and so that a financial legacy is preserved for your beneficiaries.
Premium Flexibility
You can pay premiums with new money or use the cash value growth to pay premiums overtime.
Potential Cost Savings
Lower LTC Insurance Premiums
The RCA may have less overall cost compared to traditional long term care insurance premiums if you will not need LTC services.
Tax Efficiency
Tax advantaged growth and tax free withdrawals and subject to conditions and increase your overall retirement savings.
Peace of Mind
Security in Retirement
Once you are convinced that your LTC needs may be covered and you can have a more secure and flexible retirement plan.
Potential for Growth
Market Linked Growth
Depending on the life insurance policy you choose and for example IULs and growth linked to a market index can help further enhance your retirement nest egg within the cash value.
Remember this
The RCA is not appropriate for all people. It’s critical to consult a qualified financial advisor to determine whether it’s appropriate for your individual situation and risk tolerance.
Why the Roth Conversion Alternative ?
In addition to the core benefits outlined above and an RCA can offer you a variety of other benefits depending on your individual situation
Potential for Lifetime Income
State Variations
Depending on your state’s law and the cash value within the life insurance policy may afford some kind of protection from creditors.
Spousal Benefits Available
Beneficiary Designation
You can designate your spouse as a beneficiary to ensure that the benefit continues to be available to them and maybe even some of the cash value benefits depending upon the policy.
Tax Advantages on Death Benefit
Tax free benefit
The death benefit paid to your beneficiary could in some cases be income tax free.
Potential to Have Assets Qualify
Asset Protection Strategies
Depending on how the RCA is structured and the cash value of the life insurance policy could not be considered an asset for needs based benefits including Medicaid. However you need to consult with a qualified financial advisor to understand the specific rules in your area about such strategies.
Important Considerations
Fees and Costs
Second and understand all the associated fees and costs involved in the RCA life insurance premiums and surrender charges on policies and taxation on withdrawal.
Market Fluctuations
If you choose an IUL and cash value growth is linked to a market index and which may fluctuate.
Long Term Commitment
The RCA is a long term plan. Be prepared to pay premiums at an elevated cost over a long time or strategically use cash value to help keep the policy in force.
Here are some key points you should regard as possible disadvantages that weigh against the benefits of an RCA before you make a decision to purchase. Seek the advice of a qualified financial advisor who can help you determine whether an RCA is appropriate for your overall financial goals and risk tolerance.
Disadvantages of the Roth Conversion Alternative ?
The RCA definitely has some benefits but there are also some associated disadvantages that should be considered before making any decisions.
Upfront Tax Burden
Conversion Taxes
You are liable to pay the income taxes owed on the amount converted from the traditional IRA into the life insurance policy. This upfront tax hit can be huge and depending on the amount you convert and your tax bracket.
Potential Loss of Liquidity
Access Restrictions
The cash value of the life insurance policy is subject to access restrictions and surrender charges and particularly in the early years and whereas a purely qualifying traditional IRA has no such access problems.
Taxes
Pre 59.5 age withdrawal from the cash value will be income taxable and subject to penalties.
Investment Risks
Market Performance
With an IUL and cash value growth is pegged to the performance of a market index and which may vary and could even result in losses. Policy Performance On the other hand and the performance of an RCA is dependent on the chosen life insurance policy and the investment choices of that policy.
Complexities and Potential for Misuse
Financial Expertise Required
The RCA is a sophisticated financial strategy. To understand its different components and fees and taxation and a good deal of thought must be given to these issues.
Manipulation of Cash Value
With the flexibility to access the cash value it becomes very tempting. However excessive drawings can decrease the policy value and eventually affect the very purpose for which the policy is designed for long term care or retirement income.
Possibility of Higher Overall Cost
Premiums Paid
Depending on your health and age and life insurance and chronic illness riders can turn out to be more expensive than initially anticipated.
Charges and Fees
Be aware of all the charges levied with the life insurance policy and including surrender charges and administrative fees and possible mortality and expense charges.
Not a Guaranteed Solution
Rider Restrictions
Chronic illness riders are normally subject to qualifying condition restrictions and a limited amount available to pay for LTC expenses.
Risk of Claim Denial
The insurance carrier may deny the claim for LTC benefits payable under the rider.
Not Universally Applicable
Age and Health
The RCA is not for everybody more specifically and it’s not for those near retirement age or with possible pre illnesses which could affect their qualification status or premium rate.
Financial Situation
Those with low incomes or who are approaching retirement will not be able to take so much benefit from an RCA.
Of course one has to consider the possible disadvantages that almost go against the many advantages of an RCA. It is very critical that a person consult a reputable and experienced financial adviser who has experience with RCAs and who can assess your overall finance and risk tolerance.
An alternative to Roth Conversion with the inbuilt potentials for long term care protection will have two major target audiences
Primary Target Audience
Individuals Facing Retirement 50s and 60s
This age group will likely be more interested in retirement planning and may also be more concerned about the possibility of needing long term care. Individuals in this age group have probably saved a lot through traditional IRAs and are now looking for additional tax advantages to accumulate the retirement nest egg while being cautious about the risk of health expenses in old age.
Target Audience (Secondary)
Financial Advisors and Estate Planners
This group will deal with people who are nearing retirement and seeking retirement planning advice. By being educated about the RCA they can then present a potential jewel to their clients and desire to address tax efficiency and long term care issues.
Presented below is a more detailed description of what a target market for an RCA would consist of
They are financially literate that is and they appreciate retirement planning and are comfortable with the required amount of financial sophistication.
Tax Aware
They desire to maximize after tax benefits and minimize after tax burdens in retirement.
Long Term Care Issues
They have concerns that the financial drain of long term care could affect their retirement nest egg.
Adequate Traditional IRA Balance
They have a sizable traditional IRA to justify the possible tax ramifications of conversion.
Good Health (for their age)
They will need to be insurable for the life insurance policy with chronic illness riders. However pre existing conditions may not completely disqualify but could impact premiums.
Long Term Investment Horizon
Again and this is a long term approach. They should be comfortable that their commitment will need to extend well into retirement years.
Other Factors to Consider
Risk Tolerance
Some investment risk is associated with an RCA and especially when it is purchased through an IUL. In this respect the ideal market would be someone comfortable assuming a moderate level of risk.
Estate Planning Goals
One of the attractive features about the RCA to those for whom leaving behind a legacy for beneficiaries is a concern is the death benefit associated with it. By knowing this target market the financial advisor can better tailor their discussion of the RCA to address specific needs and concerns with their clients.
Conclusion
The Roth Conversion Alternative with Long Term Care Protection represents an extremely attractive strategy for those who are near retirement and looking to balance out tax advantaged growth against the protection that may be realized in long term care. In this conversation and while it is the RCA that will most clearly present a unique bundle of benefits and careful considerations must weigh in regarding the benefits versus drawbacks and target audience and the associated complexities with implementation. This approach should be discussed with an independent financial advisor and tax advisor who can decide whether the RCA works within your personal circumstances and overall goals. Knowing this approach and its subtleties and you can decide in an informed manner towards a more confident and financially secure retirement.
