The Wall Street Journal estimates that one out of two women and one out of three men who reach age 65 will spend some time in a long-term care facility (1). The average stay is two-and-a-half years, and in Richmond the average cost is more than $50,000 per year.

Of course, many people will stay much longer than two-and-a-half years, and in some areas the cost is much higher. According to a MetLife survey, the average cost in Arlington is almost $75,000 (2). Understanding key tax and financial considerations of long-term care will help CPAs better advise clients about planning for the future.

When is the best time to buy long-term care?
To meet important financial and tax opportunities, clients should consider buying long-term care in their mid-fifties, or as soon after as practical. With many long-term care insurance policies, the cost to take out a policy rises modestly while people are in their forties and early fifties. However, when people reach their early to mid-fifties, annual premiums tend to rise dramatically each year.

For example, a $150 per day, four-year policy for a married couple with five percent compound inflation protection would cost approximately $3000 with a major long-term care carrier at age 55. At 60, the same policy with a daily benefit of $190 (this is around what the policy would pay after considering the five percent annual benefit increase) would cost approximately $4800. At 70, the cost climbs to more than $15,000 -- more than five times higher than at age 55. So if a person waits until age 70 to buy long-term care insurance, in five years he will pay more in premiums than he would have paid in 20 years by buying the coverage at age 55.

Granted, this analysis ignores the time value of money, but there are also other considerations. If the clients have a claim prior to age 70, and they enrolled at age 55, they will have coverage. Additionally, by getting coverage in their mid-fifties rather than waiting, they avoid the possibility of becoming uninsurable or insurable only with a rated premium.

Clients must understand that once they reach their mid-fifties it is important to make a decision on whether to get coverage. For some very affluent people, self -insuring may be a viable option -- but for most, waiting until they are in their sixties to purchase coverage will probably just cost them money.

Tax considerations for the employed
For clients who are employed, there may be additional advantages to enrolling in a long-term care insurance plan while they are in their fifties. IRC Sec. 106(a) states that gross income of an employee does not include employer-provided coverage under an accident and health plan. Additionally, IRC Sec. 105(b) provides that an employee does not need to include premiums paid for his spouse or dependents in his gross income.

Many key employees of small companies, such as officers, executive directors of nonprofits and top-performing salespeople, have a compensation package that is negotiable to some degree. In many cases these employees can negotiate with employers to pay some or all of the long-term care premiums for them and their spouse. If they are successful, they may receive two tax benefits. They will pay no taxes on the economic benefit of the insurance, and if they have a claim, the benefit is not taxed.

Tax considerations for the retired
Retired clients can also benefit from tax-planning opportunities. Currently, individuals ages 61 to 70 can deduct up to $2,600 of their long-term care premiums from their gross income, and those over age 70 can deduct $3,250 per year. Of course, this is limited to people who itemize their deductions and have medical expenses in excess of 7.5 percent of Adjusted Gross Income.

Unfortunately, because of the 7.5 percent medical expense limit, many retired clients will be unable to get much tax benefit from their long-term care premiums. One strategy to consider when opting for long-term care is a limited-pay policy. Limited-pay policies have substantially higher premiums, but unlike life-pay policies, you only pay for a limited period of time.

For example, a 60-year-old couple with an Adjusted Gross Income of $60,000 who bought two life-pay long-term care contracts with five percent compounded inflation protection and a $150 daily benefit would pay about $4,100 per year and receive no tax deduction. Alternatively, they could purchase two 10-year limited-pay policies with a premium of approximately twice the life- pay and receive a substantial tax deduction for the next 10 years -- and then have lifetime coverage with no additional premiums.

Interest rates and self-insurance
Affluent clients often feel they have enough assets to cover the cost of an extended stay in a long-term care facility and choose to "self-insure." While this may sound like a reasonable idea, in today’s low interest rate environment, clients need to be especially cautious about taking this approach.

An employed couple with $1 million dollars in savings today may feel they have adequate resources to cover the costs of long-term care. However, many investors get more conservative after they retire and invest more heavily in fixed-income investments. For fixed income investors, the cost of long-term care can easily increase much faster than their portfolio with today’s low interest rates, especially if they are using some of their interest to support their standard of living. For some clients, self-insuring that looks good at age 55 turns out to be a poor choice at age 85.

CPAs have a real opportunity to help clients prepare for the future. While it may be a difficult subject to broach, many clients will make better decisions if they discuss the topic with their CPA before they make a choice.

1. Luccette Lagnado, "Living and Dying," Wall Street Journal, February 21, 2001.
2. MetLife Market Survey on Nursing Home and Home Care Costs, 2002, http://www.metlife.com/.

ROBERT J. FISCHER, CFP, is a first vice president of investments in the Richmond office of Legg Mason Wood Walker Inc., a diversified securities brokerage and financial service firm. His specialty includes tax advantaged investing and qualified plans. Contact him at RJFischer@leggmason.com.