A Realistic Approach to Long-Term Care

When it comes to long-term planning, the realist has an edge. No one wants to think about the prospect of his or her own failing health, but considering it now, in the short run, may make your future more comfortable and secure. One of the most important realities to face is that as people’s longevity has increased over the latter half of the last century, so has the need for long-term care (LTC). While the services available for assistance, such as nursing homes, assisted living facilities (ALFs), adult daycare centers, and in-home care options, have expanded and improved to keep pace with the “graying of America,” public programs and private health insurers have not necessarily adjusted to make long-term care a funding consideration.

The Real Need for Long-Term Care

Long-term care refers to the broad range of services that assists those with chronic conditions in performing the essential activities of daily living (ADLs), such as getting around the house, dressing, bathing, or eating, or the instrumental activities of daily living (IADLs), such as traveling outside the home, preparing meals, or taking medication. A person is generally considered to be in need of long-term care if he or she has difficulty performing two or more ADLs or IADLs, because of physical limitations, cognitive impairments, or both.

Already, increased longevity has spurred a “Sandwich Generation”—people who have the dual responsibilities of caring for aging relatives, as well as children. With public programs and private health insurers providing only limited coverage for long-term care, the burden of costs and services often falls on younger generations.

Funding Realities

No public program—neither Medicare nor Medicaid—is specifically designed to fund long-term care. While many people mistakenly assume Medicare will cover the costs, it actually only covers short-term care. Medigap—private health insurance intended to supplement Medicare—also generally does not pay for costs associated with long-term care. As a result, Medicaid has become, by default, the primary funding source, but an individual must be in a position of financial need to receive assistance.

A Real Alternative

An increasingly popular insurance alternative has emerged to alleviate the strain long-term care may place on your savings and younger generations—long-term care insurance. Long-term care insurance can help pay for long-term care expenses before you or a loved one become eligible for Medicaid, and it may allow you to keep significantly more of your savings. A policy tailored for your needs may assume the costs of a nursing home, an assisted living facility, adult day care, and/or care in the home. In addition, participation in certain policies makes you eligible for tax deductions. Thinking about it in the short run may save you in the long run.

Securing long-term care insurance is a realistic approach that may enable you to maintain your quality of life, while offering you, or a loved one, financial independence and increased options for care.

Nonqualified Deferred Compensation Plans

If your business has certain executives who are vital to its success, providing them with a nonqualified deferred compensation (NQDC) plan could be a winning strategy to keep them with your company. Such a plan represents an agreement whereby one person (or legal entity) promises to compensate another for services to be rendered currently, with actual payment for those services delayed until sometime in the future. As an employer, you are offering an employee extra income that will not be taxed until some future date, usually upon retirement or death, disability, or termination of employment.

From a business standpoint, creating the funding mechanism to help ensure NQDC benefits are there when the employee is entitled to them is the foundation of any plan. From a tax standpoint, making sure that the employee’s benefits are taxed when received, and not before, is equally critical. It is particularly important to get professional advice on the Internal Revenue Service’s “constructive receipt doctrine,” as well as other tax issues related to NQDC plans.

It’s likely that your company already offers a qualified retirement plan, such as a 401(k), which provides the employer with tax deductions for contributions up to a certain limit made to a participant’s retirement account. While these contributions certainly help employees reduce their taxable incomes and defer taxes on earnings from contributions, qualified plans do not pack the financial wallop highly paid executives are seeking. This is because qualified plans usually limit the compensation base used to determine the maximum annual contribution. With no limit on the compensation base, deferred compensation plans can transform a standard benefits package into a financially appealing savings vehicle for selected employees.

A Tender Tether

Explicit in the deferred compensation plan is a contractual promise to provide future payment for ongoing services. Tethering an employee to the company through a vesting agreement is often included in a plan, although many plans offer immediate vesting, which is to the employee’s advantage.

For example, an employer may stipulate that the employee stay with the company for a certain number of years before the employee is entitled to the compensation. Such an agreement encourages loyalty and commitment on the part of the employee. Prohibiting employment with a competitor (a noncompete agreement) can be another condition of the agreement.

What’s in the Pipeline?

The agreement you make with an employee will specify the type of benefits and how and when they will be made available. Salary continuation—say, providing $10,000 per month for life beginning at retirement—and annual contributions to an investment account where the balance is then paid at retirement—are typical benefit formulas of NQDCs. Whether the money is actually set aside into an account, or merely exists on your books, is up to you. Employers who offer these plans, however, must be confident that the future profitability of their businesses will cover promised payments.

Employees, for their part, will want assurance that their compensation will be there for them. One method of providing assurance is to set up a rabbi trust, which is a type of escrow account that provides some protection for the deferred compensation funds in the event of a hostile takeover or other type of management change (but is not protected from the claims of the employer’s general creditors). The protected funds may be invested in many ways, for example in mutual funds and in individual stocks and bonds, or may be used to purchase life insurance or annuity products. (Investors should be aware that investment returns and principal values of mutual funds and other securities will fluctuate due to market conditions. Therefore, when shares are redeemed, they may be worth more or less than their original cost.)

As Americans take on more responsibility for funding their own retirement, NQDCs may become a standard component of benefit packages. Because these plans are not governed by federal pension laws, they can be extremely flexible. Their very flexibility—and their associated risks— however, mean that you should seek professional counsel from tax, legal, and financial professionals prior to implementation.

If You Were Furloughed, Do You Have Cash?

The partial government shutdown resulting in 800,000 federal workers across the county not receiving pay is a wake up call. If you are lucky enough not to be one of those employees, or one of those contractors and supporting jobs affected by the shut down, this event should raise a question in your mind about your emergency fund. Typical guidance says 3-6 months of expenses. As far as rules of thumbs that is a good choice but further analysis can refine that number and make your personal financial situation more secure.

This begs the question of how much cash you should maintain for life’s emergencies – a job loss, a big medical bill, a legal liability or a government shutdown. The answer might surprise you. As will knowing that the older you get, the more you need.

Early in adulthood, we need lower emergency cash savings. Then life gets more complex. You likely have more people who rely on you, and so the risks of job loss are greater. Maybe you work in a cyclical industry or are self-employed. This involves parking a chunk of your income in cash instruments: bank savings accounts, certificates of deposit (those without long maturities so you can access your money more easily) and Treasury bills.

Here’s a recommendation of how much cash to have:

Young Adults

For individuals, couples or families just starting out on their financial journeys, three months is the bare minimum. But you may need to achieve this goal through slow and deliberate savings. Start by setting aside $10 to $20 per month and living within the remainder. If you can do more, do more. Increase this as you are able, but keep it right at the edge of your comfort zone and only dip into the savings for true emergencies.

Middle Years

When you are in the middle of your working life – say, 35 to 60 years old – you probably are busily investing to meet goals like retirement and college payments. Meanwhile, there is the added risk of job loss, or perhaps simply job dissatisfaction. You may want to make a change before it is too late. Odds are you have a family to support. You need a bigger safety net: six to 12 months.

This safety net pays for living expenses while you are out of work, or if you change direction and quit a job. Some refer to this as F.U. savings, for when you just can't take your boss for one more day. This is more and more important as companies maintain profitability through layoffs. People are working harder to keep their jobs. Even if you never use the emergency money, having it gives you financial confidence.

Nearing Retirement

When you are nearing that magical moment of maximum freedom, retirement (meaning approaching age 65), keep one to two years in safety money. This is because, with pensions sparse, your entire future retirement income is probably tied up in assets invested in unpredictable markets.

It’s easy to think that this 10-year bull market – which may or may not be ending – will continue forever. After all, last year was the first year in a decade that saw the S&P 500 dip into negative territory. But remember what happened 10 years ago? The market plunged 37% in a single year.

You need a buffer to protect you and keep your plans on track – a place to draw from not subject to market fluctuations. Otherwise, a major market drop may force you into taking a later retirement.

In Retirement

Ideally, once retired, you need a minimum of two years of emergency savings ready, just in case markets take a major tumble.

When people hear about building emergency savings, this is often the objection: “There is no return on these safe assets.”

True, cash returns are incredibly low these days, almost non-existent. But remember, given the uncharted waters we are in economically, it makes sense to enhance our safety nets.

You might be a huge optimist, and believe the future will be incredibly rosy. Still, you won’t know when those big temporary setbacks will occur – but they will occur. So, you should plan for them to arrive when you don't expect them.  

Another objection: “Taking care of both investments to meet life goals and a large safety net requires even more of one’s income.”

The answer to this: Yes, absolutely.

Sure, it’s true that if you don’t fund your safety net, you can divert more money into a higher standard of living for today or into greater investment assets for tomorrow. But eventually, something will happen in your life, an event that calls for a sum of cash waiting patiently on the sidelines.

Your comprehensive financial plan should allow you to see the wisdom of a balanced approach that includes a sizable safety net. If it doesn’t, then it’s not comprehensive.