Charlie Gipple, CFP, CLU, ChFC

Some of my fondest memories as a kid have to do with being on the lake in a boat enjoying water sports. So once I had kids it became a burning desire to torture them as I drove the boat and they held on to the tubes for dear life. So, we bought a boat!

It is no secret when I say that buying a boat, in addition to the SUV that is required to pull the boat, costs a small fortune. Buying one of those items costs a small fortune let alone both of them. So, here is a thought: Wouldn’t it be nice if my Suburban also worked as a boat to spare me the cost of buying the boat and the hassle of hauling the boat around? If my Suburban came with the “Amphibious Option?” Even if that option cost a little more, it would probably be cheaper than buying a boat in addition to the Suburban. Unfortunately, GM does not offer that option yet.

Although the life insurance industry has not traditionally been known for innovation, this is an area where we have innovated beyond vehicle manufacturers (sarcasm). The “amphibious” option is indeed available with life insurance policies and annuities when it comes to long term care coverage.

Below, I want to highlight a particular product/strategy that I like. I call this product “the amphibious life insurance product.” Although I am discussing one of my favorite products here—which I can share with you if you email me—it is not about this specific product but rather the concept. Afterall, this is not the only product and rider out there of this kind. I will not name names in order to remain compliant with the carriers.

Case study: You have a 50-year-old male that would like some level of life insurance coverage in order to provide an inheritance to his kids. This client is also concerned about the expenses associated with long term care/chronic illness that he will likely experience in his later years. You, the agent, believe that $300,000 in life insurance coverage would do the job. You will also look to a product that will provide a large long term care/chronic illness benefit should he need care.

When one of my agents comes to me to ask for help in scenarios like this, one of the first things I will do is check life insurance prices across the entire industry for this particular client. To do this, I will run a report to find a list of the lowest cost policies that will guarantee his $300,000 in death benefit that will be guaranteed forever. “Forever” is defined as to age 121. This will be a starting point for how much the “SUV” costs, to use my previous analogy. Nine times out of ten the product I am highlighting will be in the top three from a price standpoint. Using our 50-year-old male (standard health) who is seeking $300k in death benefit, the product I am referring to is the #2 in lowest premium, at $4,014 per year. Again, that is just for the death benefit coverage—the SUV. This is our starting point.

However, how do we make this product “amphibious?” Where that entire $300k applies not just to death benefit coverage but also to long term care coverage? The answer to the question is, we would add a chronic illness rider to the policy which comes at an additional cost. What I tell clients is, “The old-fashioned life insurance tells you that there is only one way to get the death benefit; you have to go and die, which is not fun. However, by adding this rider, it will give you an additional trigger where you can activate the death benefit during your life. It’s life insurance, not death insurance!” Effectively what the client is doing is they are upgrading their SUV by adding the “amphibious” option that applies not just to death but also to long term care.

By adding this rider you can point to the $300,000 death benefit and tell that client that the $300,000 will be paid out—whether in life or after death. I also like the riders that do not cost any additional premium. However, the “discounted death benefit” upon chronic illness does not allow us to tell the client with certainty that they and/or their heirs will get the entire $300,000. The actual chronic illness benefit can be uncertain with many of the discounted death benefit riders because the actual cost to the client is experienced on the backend, at claim time. The rider I am discussing has no “discount” at claim time.

How much does this guaranteed universal life policy cost with the “amphibious option?” $4,663. In other words, by adding the chronic illness rider, we added $649 ($4,663 minus $4,014) to the premium. That is what it costs to upgrade our SUV to also work as a boat. Illustration Details: For this rider, I chose a maximum acceleration of $8,000 per month for the chronic illness payout. That would give us a 37.5-month benefit period, calculated by dividing the $300k death benefit by $8,000.

Even after adding the additional cost of the chronic illness rider, the premium on this policy is still within the top seven GUL policies in the industry—at least in this exact example.

So, the death benefit coverage on this product is exceptionally low cost but what about the cost of the chronic illness rider? Instead of adding the chronic illness rider to our policy, what if we bought a stand-alone LTCI policy with similar benefits? What would that LTCI policy cost per year in premium? $1,443, or $794 more than the cost of our chronic illness rider. Illustration Details: The long term care policy I illustrated provides an $8,000 per month benefit for 36 months. There was no “37.5 month benefit period” so I went as close as I could. Also note, I chose no inflation options to make it apples to apples. This is technically a $288,000 benefit pool, calculated by $8,000 per month times 36 months.

As I summarize everything in the spreadsheet, by going with the one life product, plus the chronic illness rider, the premium is cheaper than the total premium of the life policy plus the LTCI policy. The savings is $794 per year in premium. With that said, it is important to understand that you cannot market chronic illness riders as “long term care,” as that is prohibited. Also understand that stand-alone LTCI policies are much more “modular” and have many more options (inflation, elimination periods, partnership, etc.) than chronic illness riders. In other words, if I turn my suburban into a boat, I will likely be limited in how my suburban performs on the water relative to if I bought an actual boat. Needless to say, a Suburban is not an apples-to-apples comparison to a boat!

In my perfect world, everybody would have the means to buy an LTCI policy that provides at least $8,000/month benefits, with long benefit periods, and five percent lifetime inflation. However, considering we do not live in a perfect world, this strategy can provide immense value to those consumers that need death benefit coverage and also lower-cost alternatives to the fully-loaded long term care options that exist.

One more thing: You can also look to the “indexed GUL” policy that this company has. This can be a strategy to further bring down the price. Assuming a 3.25 percent illustrated rate on the indexed life policy, as well as current policy charges, what is the premium it would take to carry our $300k policy out to 121? Only $3,606. That number includes our chronic illness rider that will provide $8,000 per month of benefits for 37.5 months. For the skeptical folks (like me) that are wondering if the death benefit is guaranteed if the market were to be down forever and COI charges were to increase to the max—the death benefit is guaranteed to age 86 as long as the premiums are paid.

There are a few annuity and life insurance social media groups in which I am a “group expert.” These social media chat groups are closed groups that are only available to financial professionals where they can ask questions and comment on ideas and strategies that are working for them. It is also a forum for which other financial professionals can respond to the feedback and strategies communicated.

Some of these groups have thousands of financial professionals in them and are wonderful resources, not just for the agents but also for me as an independent marketing organization. These forums not only allow me to contribute but also allow me to learn what is on the minds of the agents.

With the large quantity of financial professionals in these groups and also the ease of those financial professionals to just type up a message and let it fly, it can serve as unfiltered insight into what is working, what is not working, misperceptions, etc. When I say it is “unfiltered” that is because it is extremely easy for some people to speak their mind when they are sitting behind a computer. If you have ever spent any time at all on a social media platform, you know what I am talking about. Unfortunately, sometimes the conversation goes something like the below. Pardon the satire but I’m sure you understand:

Person trying to help: “I think oranges are a great tasting fruit because…”

Person that knows nothing about the conversation topic: “Are you kidding! Apples are horrible! I would never recommend them to my clients. Make sure your E and O is updated.”

Person trying to help: “I am talking about how oranges are great tasting fruits, not apples.”

Person that knows nothing about the conversation topic: “Who would ever recommend apples to clients? Plus, they are not fruits, they are vegetables. That is stupid. My Brazilian Butternut Cantaloupe is ten times the vegetable that your apple is.”

Person trying to help: “I’m talking about oranges and fruit, not apples and vegetables!”

Person that knows nothing about the conversation topic: “I see, so now you’re trying to change the topic huh?”

And before you know it, the strategy that you wanted to share about your oranges has gone the way of the dinosaur, kind of like my point to this column, as I have digressed.

What is my point? My point is that I see a lot of glaring misperceptions that are often laid out very publicly and obviously, although a little more nuanced than apples versus oranges. Much of those nuances have to do with the complicated world of long term care hybrid products. So, why not address some of those examples where I have seen rampant confusion. By the way, although I poke fun in my social media example above, much of the confusion around hybrid products is warranted as the industry has gotten very commingled and more complicated. But don’t take “complicated” as not exciting, because the long term care hybrid world is indeed extremely exciting and lucrative if you know what you are doing.

Not Many Understand The Entire Universe Of Long Term Care Products
If you are a visual person like me, a slide from one of my agent training decks will help us visualize the universe of long term care products. This may not be the “entire universe,” but it is close!

The slide shows that the universe can be broken into three different “worlds.” Although there are exceptions, what I tried to do was to arrange the chart to demonstrate the products with the most long term care leverage on the left, with the leverage dropping as you move to the right. Of course, when we get into single pay scenarios (life and annuity) it gets a little more complicated however.

Starting from the left, you have the granddaddy of them all, traditional stand-alone long term care. To oversimplify, this works like health insurance. Again, it will generally provide the most long term care leverage, per dollar of premium.

Secondly, you have the “world” that represents a large majority of the entire universe today—as measured by industry wide cases sold. These are the combination/hybrid products. These are annuities or life insurance with a long term care benefit attached in the form of a “rider.” Within this world you have several variations of these combo/hybrid products. We will come back to this because this is where much of the confusion lies—and thus opportunity.

Third, you have annuities that have waivers of surrender charges for nursing home confinement or “doublers” on the GLWB payouts. The long term care protection afforded by these products are usually a distant need relative to the other benefits these annuities possess. The long term care benefits on these generally have no underwriting.

“Combination Products” Is Not Synonymous To “Linked Benefit Products”
As you can see from the graphic, the “Combo/Hybrid” world is separated into two different continents, the Linked Benefit continent, and the Accelerated Death Benefit continent. Let’s start with the accelerated death benefit products.

Accelerated Death Benefit Products: These are usually life insurance-based products where the death benefit (and no more than the death benefit) can be accelerated for the purposes of a long term care event or a chronic illness. When I present this product, I like to point out that the life insurance of the old days typically had one “trigger” in order to access the death benefit—death. Well, today’s life insurance is life insurance, not death insurance.

Accelerated Death Benefit Riders are where the insured can actually get relief out of the product during their lifetimes in the event of a chronic illness or a long term care event. Thus, the two prominent rider types offered within this category are “chronic illness riders” and “long term care riders.” Once upon a time chronic illness riders required a permanent condition, which made true long term care riders generally more attractive than the chronic illness riders. Since NAIC Model Reg changes in 2014, this condition of permanence is no longer the case for the most part. Therefore, the differences between long term care riders and chronic illness riders are very slim.

Linked Benefit Products: Again, linked benefit products are a subcategory of the broader “combination product/hybrid” world. People tend to think “combo products” are “linked benefit” products and vice versa. Not so! One is a sub-component of the other.

These products are usually life insurance products where there is a long term care “pool” that is created that can be multiples of the death benefit provided by the underlying life insurance product. Of course, the additional long term care pool would come at an extra cost and possibly additional underwriting relative to just an “acceleration” product.

A linked benefit life insurance product might give two to three times the death benefit in the form of a long term care pool. The long term care benefits that go beyond the total death benefit are through the use of a “continuation of benefits” or “extension of benefits” rider. Thus, the COB/EOB is the primary difference between the linked benefit category and the accelerated death benefit category.

Real Life Numbers (Company Name Omitted): The client is a healthy 55-year-old female. She does a single pay of $100,000 in premium into XYZ Linked Benefit life product. The death benefit is $152,000 and the long term care pool is $456,000. (Note: Benefit periods, etc. I won’t go into here.) When the client goes on claim, the $152,000 that is the death benefit is used up first as an “acceleration of death benefit.” Once that is depleted, the client moves into the second phase, the continuation/extension of benefits. Again, it is that second phase that separates the linked benefits from the rest of the combo/hybrid world.

As noted in last month’s column, one of my favorite products is actually a “linked benefit” annuity product that triples the clients premium for purposes of long term care, with almost no underwriting! That is the box on the lower left side of my graphic. Think “Live, Die, or Quit.” If the client lives and needs care, he/she gets three times the contract value. If he/she dies, the bene gets the contract value, which is what the client put in plus growth (usually). If he/she wants to “quit,” they get the contract value—or surrender value if within the surrender period.

Chronic Illness Riders Are Generally Not FREE!
The most common misperception that I see is the notion that chronic illness riders on life insurance are free. Unless there is one in some corner of the industry that I have never seen, I will say they are not free. You either pay for them upfront via an additional premium (morbidity charge) or the client pays on the backend when they elect the chronic illness payout. There is also a third—a lien structure—that I won’t go into here.

The most common chronic illness structure is the “backend,” otherwise known as the “discounted death benefit” structure. To be clear, there is no cost on this rider if the client never uses it—which is one of the reasons to like this type of rider. However, if the client uses it, the ultimate cash in hand to the client is less than what the death benefit was actually reduced by. The difference between those two numbers is effectively the cost to the client and the beneficiaries. Example: Client goes on chronic illness claim and the death benefit is reduced by $100,000. How much cash might the client get in hand? Maybe $80,000. Hence, the $20,000 difference between the death benefit reduction and what was received can be considered the “cost.”

With the discounted death benefit design, the amount that a client ultimately gets is usually not known until claim. That is because the calculation is usually the death benefit discounted back to the date of claim by a discount interest rate that is not known until the actual claim. Again, however, if the client never goes on claim they never paid a penny for the rider. It is a great rider, but it is important to note that it is not always “free.”

One of my favorites is an “upfront” rider that does have the additional charge to the client as they pay their premium. Why do I like this one? Because the client knows exactly what they will get when it comes time to claim. There is generally not a discount on the death benefit on these types of riders. You either pay upfront, or you pay on the backend. With this rider, you can point to the death benefit on the ledger and tell your clients that whether in life or after death, somebody will indeed get that value. Of course, as long as they pay the premium!

Summary
There is a lot to know about the long term care Universe. We did not even get into reimbursement versus indemnification, 101g versus 7702b, per diem limits and taxation, etc. One thing I learned a long time ago is that there is no life, annuity, or long term care option that is “the best.” It is client specific. A benefit that is “the best” for one client, may be too expensive for another. Said another way, with these products there is always a counterbalance that makes the task of finding “the best” not so simple.

I am going to eat my orange now.

As I discuss this particular product type as being a “low friction” long term care sale, I do not want the reader to gather that the main reason to sell it is because it’s a “layup” sale whereas the client will give up value versus a better/higher friction product. After all, I will always work to educate my clients on the right product, whether that sale is “high friction” or not. And although I think that many clients’ best product choice should be a fully loaded, long term care Partnership approved, $8,000 a month benefit with a five percent inflation rider, that does not always fly for consumers because of price, misconceptions about the various long term care insurance options, etc. Let’s face it, getting the client to pay $2k to $10k a year ongoing premium—depending on the client—can be met with a good amount of negativity from the consumer.

Outside of the ongoing premium, standalone long term care policies have two primary areas where consumers criticize them:

• Premiums have historically increased substantially.
• If the client doesn’t use it, they lose it. If they die without ever needing care, they “wasted” their premium.

Although these perceptions are not unfounded, I do like traditional long term care insurance because, per dollar of premium, you generally get the highest long term care leverage of any of the products. Plus, I believe premiums are much more sustainable on the new generation of products because of updated lapse and interest assumptions priced into the products. But again, sometimes convincing clients to go that direction is a lost cause.

Before discussing the product, a great sales strategy is to address the concerns that you know consumers will bring up before they even bring it up. That tells the consumer that you understand what their concerns are without them having to prompt you. I previously mentioned the two main concerns that consumers have with traditional long term care insurance. And most consumers don’t realize that there are other long term care options beyond traditional/standalone. So, by discussing the following points, you can usually get the attention of the consumers that have preconceived notions about long term care insurance.

“Many times, consumers have two different concerns around long term care insurance—premium increases and the fact that if you never need the care, you have effectively “wasted” the premium you paid. Well, those concerns have basically been addressed with the particular solution I would like to introduce you to.”

As you articulate the above paragraph, your prospect/client would have been nodding his/her head before you finished it.

What is this product I am referring to? It is a long term care annuity, also known as a “linked benefit annuity” or a “hybrid annuity.” I prefer to call it a long term care annuity because it more explicitly tells the client what the product does. Anyway, the chassis itself is like a traditional fixed annuity whereas the interest rate is guaranteed for the first year but then can float, and likely will float. A common interest rate today is close to three percent in the first year with a minimum rate in the following years around one percent. Additionally, there is a relatively small monthly long term care fee deducted from the client’s value on a monthly basis. Now, if the client ever wanted to cash out this “accumulation value” they can do that like any other annuity. Just keep in mind that–like most annuities—there are surrender charges that go anywhere from five years to 10 years, depending on the product.

So far what I have just talked about is just like any other traditional fixed annuity. A particular type of consumer is already interested, and I haven’t even gotten to the long term care part! That “particular type of consumer” I am referring to is the one that has their money in a certificate of deposit for example—earning nothing! Just last week I got to this point in the presentation on this long term care annuity and the client said, “Why would I not do this?” I said, “Well hold on, we haven’t even gotten to the main reason to consider this solution, the long term care benefit.”

Now to the good part. What is the long term care benefit? It is triple what the accumulation value is. So, if the client puts in $100,000, and that $100,000 has grown to $110,000, the long term care pool is $330,000. Generally, the client gets access to the $330,000 once he or she cannot do two activities of daily living for a 90-day period.

One thing to note is, it’s not like the client can just cash out the entire $330,000 at the time they qualify for the long term care benefits. That type of product would not be sustainable for carriers. When you think of long term care insurance pricing, for a given long term care pool insurance carriers are on the hook for larger risks the faster they let the client tap into that long term care pool. So, naturally, there are benefit periods that these carriers have priced into these policies. The common benefit period is 72 months (or 6 years) with the products I am referring to. So, in my previous example, $330,000 divided by six years is $55,000 per year that the client can be “reimbursed” for from the policy when it comes to long term care benefits. This means that if the client is in the nursing home or received in-home care for a period of six years, and if at least $55,000 per year was spent on that care, our client would receive $330,000 in tax free benefits even though they only paid $100,000 in premium.

By the way, underwriting on these types of policies is basically non-existent. Underwriting is about ten to fifteen “knockout questions” and a 30-minute phone interview with an underwriter.

Now, a few negatives:

1. The Benefit is Spread Out: As mentioned, for a given long term care pool, the higher the benefit period is, the less the risk is that the insurance company will pay out the entire $330,000. This is because if the consumer were to only be in the nursing home for three years and then pass away, the insurance company would have only been on the hook for $165,000 ($55,000 x three years). So again, for a given long term care pool, the shorter the benefit period is, the better for the consumer and riskier for the insurance company. The six-year guideline is a bit of a negative because statistics show that nursing home stays are less than three years on average. However, with the rise of cognitive issues like dementia, I don’t feel a whole lot of heartburn with the six-year benefit period. Long term care events have been trending longer over the last couple of decades because of cognitive illnesses.
2. High Deductible: You can think of these policies as being “high deductible” policies. In other words, when the $330,000 is tapped into, the first two years is actually the client’s money (accumulation value) coming out first. Then, in the third year, that is when the consumer is dipping into the insurance company’s pocket.
3. The Fee: There is a long term care fee that is deducted monthly from these policies. However, if you were to illustrate a traditional LTCI policy with the same long term care pool, you would find that many times the traditional LTCI premium would be multiples of the factor that is deducted from these long term care annuity policies. This is partially because of the “high deductible” nature of these policies. Also, with these policies, that fee is generally guaranteed to never increase!
4. Limited Options: Options around inflation benefits and various benefit periods are basically non-existent with these types of products, whereas standalone LTCI, and also the life insurance based long term care hybrids have more robust options. However, you certainly pay for those options!

Even with the negatives that I mentioned, it is still a very low friction sale because of the fact that in the end the consumer is often able to get more interest out of the policy than what they were getting in a certificate of deposit even after the long term care fee is deducted. Therefore, our low interest rate environment makes it an ideal time to present these products to your clients.

An Analogy for Consumers:
Let’s say that your $100,000 is a very tasty but magical fruit. You can eat (spend) that fruit of $100,000 anytime you like right now. Conversely, there is a way where you can take this magical fruit and plant it. By doing so, it will immediately bear a tree that will have three of those fruits. You have tripled your fruit. Kind of cool huh? Granted, this tree will require a little watering and nurturing (long term care fees) but that is what allows you to have triple the fruit that you have right now. The only rule is when you do start eating this awesome fruit, you cannot eat any more than 1/2 of one fruit (one-sixth of the total) each year in order for you to not shock and kill the tree. We do not want the tree to die before harvesting all three fruits (the $300k long term care pool). Granted, you can rip your one fruit (surrender value) off the tree anytime if you like, but it’s wiser if you eat only half a fruit at a time to not shock the tree. That is effectively how this product works.

Lately I have been conducting training for the agents of CG Financial Group on estate planning. When I talk with folks to invite them to these webinars, I will occasionally have a few of them question just how useful estate planning is in today’s day and age when the lifetime estate tax exemption is $12.06 million (2022) for a single person and $24.12 million for a married couple. (Note: Any estates beyond this size are subject to a 40 percent estate tax.) Their skepticism is warranted because not many families have over $12 million. However, as the cliché goes—we need to observe where the puck is going versus where it is now. Or, in my previous columns I have spoken about another cliché—the “Pig Through the Python.”

The “Pig Through the Python” refers to the giant chunk of Americans that are currently working their way through their 60s and 70s. These are the baby boomers. This demographic “pig” in the python is not just about the size of the baby boomer population, it is also about the wealth they own—which is well over half of our country’s wealth depending on what measure you reference. As this very large and wealthy demographic cohort gets digested and pushed “to the right” of the age chart, it’s important to think about the financial phases this influential group will go through.

From a financial standpoint I view the baby boomer generation as generally having three more “phases” left to complete:

1. Right now, the youngest baby boomers are in their pre-retirement years (age 58) and are planning for the “Decumulation’’ phase of their retirement. Of course, the older baby boomers are already in this phase. This is where the rhetorical pig currently is, which is why it is easy for an agent to be exclusively focused on income planning.
2. The second phase of retirement that some of the older baby boomers have already dealt with is the “Extended Care” phase. If long term care is not a part of your practice, I would make it a part—or partner with a long term care expert where you can split cases. The pig is coming that direction!
3. The third phase that baby boomers and their families—and all of us for that matter—will deal with is the “Wealth Transfer” stage. Unless we find a way to prevent death, every single one of us—or our families—will deal with transferring our wealth. Whether we plan it or not, this transfer will happen after we die in 100 percent of our scenarios. And successfully transferring wealth to the next generation requires estate planning.

Again, with today’s large estate tax exemption, it is hard to imagine a world where we are consistently discussing estate planning. However, we all know things can change, and likely will change, with the amount of debt our country is in and with the popularity of targeting “the rich.” As a matter of fact, things are scheduled to change! In 2026 the “Tax Cuts and Jobs Act” sunsetting will mean that the estate tax exemption will go back to 2017 levels—$5.6 million per individual and $11.2 million for a married couple. Although I am fully cognizant that this number is still very high and still excludes a lot of folks, again, things can change! As a matter of fact, the Biden plan is for the estate tax and gift tax exemption to be $3.5 million. Considering that estate sizes can easily double between now and your client’s death, the prospect of a $3.5 million exemption puts a lot more people in the crosshairs of the estate tax. I know a lot of folks that have $2 million estates whereas they would have an estate tax issue if their estates were to double in size assuming a $3.5 million exemption.

In my previous sentence, if the current estate tax exemption was $3.5 million, and if I projected that my $2 million estate would eventually hit $4 million, my estate would be subject to a $200,000 tax (40 percent on $500,000). A way to minimize this tax might be if I “gifted” the present value of $500,000 (or more) today so that my estate does not exceed the $3.5 million in the future. And the “present value” may only be $250,000 for example. That is just a very simplified example of estate planning with gifting. Technically, I would want to give more than the present value of $500k but I won’t go there!

A Quick Note on Gifting
Many people don’t understand the value of gifting because, after all, for every dollar you gift above the annual exclusion it reduces your estate tax exemption dollar for dollar. So, either way, you are going to be taxed 40 percent once your gift/estate tax exemption is expended. Then what is the reason for gifting? If you look at my simplified example, I only lost $250,000 off of my exemptions versus the $500,000 that it would be if I let that asset grow in my possession then died with it! A lot of estate planning has to do with “freezing” the asset sizes and thus the estate size. This “freezing” can be done by gifting but also by using much more sophisticated tools than what I used above. There are Grantor Retained Annuity Trusts (GRATs), business entities, charitable trusts of various kinds, intra-family loans, etc.

More Than Just Estate Taxes
Lastly, estate planning has to do with so much more than just “estate taxes.” It also has to do with income taxes (IRS), estate preservation (long term care), annuities, life insurance, and probate avoidance. So, don’t let the current large estate tax exemptions dissuade you from sharpening up on estate planning. That is where the “pig” is heading.

With the tax increases that will almost inevitably happen, the entire world is talking about Roth IRA‘s. So, I thought it would be good to give some basic and not-so-basic information on Roth IRA‘s, Roth conversions, order of withdrawals, etc.

First off, I say all the time that we in financial services “normalize our excellence.“ Now this may sound arrogant, but it is not meant to be. Basically, all that I mean by this is that what we know by the back of our hand many consumers do not know. For example, many consumers do not know what the difference is between a traditional IRA and a Roth IRA. This is hard for many agents to comprehend but it is the truth.

So, let’s start out basic and discuss how I explain the differences. I usually draw out Diagram 1 for clients as I explain the traditional IRA versus Roth IRA concept.

Explaining Roths Versus Traditional IRAs
What I say is, on the right-hand side you are paying taxes on the “seed,” and on the left-hand side you are paying taxes on the “harvest.” In other words, with one you are putting in after-tax dollars in order to be tax-free at retirement. With the other, you get the deduction, but those chickens come home to roost in retirement. I also usually tell the client, “Now, the seed versus the harvest is a nice catchy line I know, but without getting into the math on which one is better, the decision really comes down to your expectations of tax rates at retirement versus today. As much debate as there is around which one to go with, it is really as simple as this: If you believe tax rates will be higher in retirement than today, go with the Roth. And vice versa.” I usually also let the client know that there are some additional benefits to the Roth IRA in that withdrawals do not add to your “provisional income“ which determines if your Social Security is taxable.

Now, there is more to the story when it comes to Roth IRAs. What happens if you don’t wait five years? Or, what happens if you are not 59 1/2 when you take out the withdrawals? Or, what if you are 59 1/2 when you take out withdrawals but have not had the Roth IRA for at least five years? Etc. etc. This is where I will discuss the intricacies of how money withdrawn from Roth IRAs is treated in various situations.

First and foremost, in general, if you have had any Roth IRA established—not just the one you are withdrawing from—for at least five years and are age 59 1/2 or older, you can take out what you put in plus the growth without paying any taxes at all. And without having that dollar amount added to your “provisional income” for social security purposes.

But life isn’t always that easy. So, let’s get into the nitty gritty.

Order of Withdrawals
Diagram 2 represents the order of withdrawals from a Roth IRA. It is a lot like drinking with a straw. Depending on the density of the fluids, many times what you pour into the cup first stays on the bottom, then the next mixture is layered on top of it and then the next mixture is on the very top. Ever pour a stiff drink where you put the alcohol in first and you forget to stir it? The first thing up the straw is 100% alcohol! That is my analogy for a “first in first out“ treatment. This is the treatment that Roth IRAs enjoy. When you take withdrawals out of the Roth IRA, your contributions come out first, then any amounts you had previously converted to the Roth from a Traditional IRA, then the gain.

Withdrawing Contributions
The tax treatment of contributions is what makes “FIFO” so appealing. If “Joe” is 35 years old today and put in $6,000 and had something come up next year where he needed $4,000, could he take it without any penalty? Absolutely. As the years go by and his “contributions” pile up in the Roth, he has that dollar amount that he can access at any time without a 10 percent penalty or tax. The lack of tax should be common sense because what he put in was after-tax.

Withdrawing Converted Amounts
Now let’s take our 35-year-old “Joe” again and make this a little more complicated. Let’s say that Joe put in his $6,000 contribution today, and one year from now he moved in $10,000 that he converted from a Traditional IRA. Now let’s say that a year later he wanted to access $8,000. How is that treated? (Note: Keep in mind he already paid taxes through the conversion. Therefore, this process is to determine whether he gets a 10 percent penalty or not. He cannot be taxed twice!)

His first $6,000 that was his contribution is free and clear of any taxes or penalties (again, even though he is now only 37 years old!). However, the other $2,000 that he accesses is from the conversion he did the year prior. What is the tax/penalty treatment on that money? He is not taxed on the $2,000 withdrawal because—again—he just paid taxes on the conversion the year prior. However, he is penalized 10 percent because he did not satisfy the Roth IRA five-year holding period requirement. (Note: Some folks believe that if he set up a separate Roth IRA many years ago that the clock started ticking on this conversion back then and therefore he would not get a 10 percent penalty on the conversion, at least if the first Roth was set up more than five years ago. That is false when it comes to conversions. Otherwise, you would be able to convert pre-tax money to a Roth then immediately withdraw that conversion amount and thus avoid the 10 percent penalty. The IRS is ahead of us on this one. There are separate five-year holding period requirements for conversions.)

With the converted amount, can you fail the five-year holding period requirement and not have to pay the 10 percent penalty? Yes, there are nine “Special Purposes” the IRS allows you to have to avoid the 10 percent penalty:

1. You are older than 59 ½.
2. Death.
3. Disability.
4. First home purchase (Max $10,000).
5. Medical expenses.
6. Medical insurance premiums while unemployed.
7. 72Ts or annuitization.
8. College expenses.
9. Birth/adoption.

For example, if Joe was fifty-nine when he converted to the Roth, he can take his conversion amount out six months later (59 ½) without receiving a 10 percent penalty. To keep it simple, in any of these scenarios in this article, if the client takes money (even gain) for any of the nine reasons, there will not be a 10 percent penalty. It is just a matter of if you are taxed or not.

Naturally, if Joe satisfied the five-year holding period rule and also experienced one of the nine special purposes, there is no tax and no penalty.

Withdrawing Gain Amounts
Now let’s talk about the treatment of the gains. Whether it is gain from the contributions or gain from the conversion amount, it is at the top of our glass and the last thing to be sucked out by our straw. So now let’s assume that Joe did this.

• At age 35: Contributed $6,000.
• At age 36: Put in $10,000 that was converted from a traditional IRA.
• At age 39: He wanted to access $20,000 to buy a car (Note: The Roth grew to $25,000 at this point).

In this example, Joe is taking out all three areas of our fluid in our glass. The treatment of the first two areas (contributions, conversion amount), you should know by now. No taxes on either of the two amounts but a 10 percent penalty on the conversion amount—because he failed the five-year rule. Plus, he did not meet any of the nine special purposes.

For the withdrawal of gain, he receives a 10 percent penalty and is taxed on the gain. This is because he failed the five-year test and he did not satisfy any of the nine special purposes.

Withdrawing Gain Amounts: Alternative Scenario
Now let’s alter the scenario a little bit and assume that he had taken the withdrawal for any of the reasons you see in our list of nine special purposes instead of just to buy a car. In this case, the gain would be taxed (because he did not satisfy the five-year requirement) but there would not be a 10 percent penalty. Remember, no 10 percent penalty applies if he takes the money for any of the nine reasons.

Withdrawing Gain Amounts: Another Alternative Scenario
Now let’s say that Joe, many years down the road, does indeed meet the five-year holding requirement. He has held the Roth for at least five years after his original contribution and also five years after his conversion. Does he avoid the 10 percent penalty and taxation on the gain? It depends!

If the reason is for any of the first four (59 ½, death, disability, first home) of our special purposes, he pays no tax and no penalty. For example, he is over age 59 ½. This is how most Roth IRAs are intended.

If the withdrawal of gain is because of the last five (medical expenses, medical premiums, 72Ts/annuitization, college, birth/adoption)—and thus he is not 59 ½—then he pays taxes on the gain but no 10 percent penalty is due.

If the withdrawal had nothing to do with any of the nine special purposes, he pays taxes on the gain and a 10 percent penalty even though he satisfied the five-year holding period.

Last year I had just finished a seminar to thirty pre-retirees on retirement strategies as I was approached by one of the attendees and her husband. For purposes of this article, I will call her Sarah and him John. Sarah and John were both 63 years of age and she started the conversation with “I really need your advice on something.“ It was clear she was profoundly serious about what was on her mind. Sarah immediately proceeded in the conversation with telling me that they had 250 acres of farmland that had been in her family for generations. They also had a couple of small IRAs. The total assets amounted to around $1.5 million in total assets. As you know, this is not a real common conversation to have at the front of the seminar room immediately after the seminar, but she laid it all out for me. She almost had a sense of urgency. Sarah then transitioned into how her mother had just passed away after being in the nursing home for three years. I thought I knew exactly where this conversation was going whereas she was going to ask about the various types of long term care insurance that exist. Although that was a part of our later conversations, that was not where she took the conversation next. She said, “So here is what I need guidance on. How do we protect our retirement assets and most importantly the farmland that has been in our family for generations should either of us go into the nursing home?” What she was getting at was not just long term care insurance but also Medicaid. Naturally, we took this conversation off-line to a series of appointments the following weeks.

My previous point demonstrates a couple of points:

• Number one is that there is nothing as emotionally charged in the financial lives of our consumers as long term care. Every time somebody explains the financial and emotional experience they had with a family member’s long term care process it is heartbreaking. And, as we know, it is a 70 percent probability for anyone over age 65. Thus, the need for LTCI.
• The second issue is Medicaid! How Medicaid works is something that every financial professional should be somewhat familiar with. The preconceived notion with Medicaid Planning may be that it only applies to “poor people“ on their way to the nursing homes. That is not the case, as we saw with the example of Sarah and John.

Now of course my conversation with Sarah and John included LTCI, as Medicaid is not a great alternative to having had a full-blown plan that includes LTCI. However, this couple was in crisis mode as they both were uninsurable—she had already been treated for cognitive decline and he had serious heart issues. I bring this up because some folks will view Medicaid strategies as the antithesis to a true long term care plan. It is not. It is a last resort strategy.

With that said, allow me to explain some basic concepts when it comes to Medicaid so, at the very minimum, it allows you to be “dangerous“ with the concept or at the most, pique your interest so that you research enough to become very adept at it as I have over the years. Please note that my commentary is merely meant to be a “plain English” description that gives you a basic understanding of the concepts. This is not all encompassing. Qualifying for Medicaid is one of the most complicated strategies that a financial professional can employ and therefore this column seeks to distill it down. Let’s crawl before we run.

What is Medicaid?
My unofficial definition of Medicaid for purposes of this article is: A federal/state joint health insurance program for individuals that have assets (countable assets) and income below certain levels. This is different from Medicare in that Medicare does not have maximum asset and income thresholds to qualify. Furthermore, Medicare does not cover long term care beyond one hundred days. Medicaid does. Although there are many requirements and parameters that the federal government creates for Medicaid, there is some flexibility—and thus differences—among the individual states. The states create rules within the framework of the federal government.

What is the Process?
Once you enter the realm of Medicaid strategies, you are in “crisis planning mode.” Once a consumer is in a situation where Medicaid is the last resort, the process might look like the below.

This is the process of preserving assets in situations where those hard-earned assets would otherwise need to be liquidated in order to fund long term care expenses. For example, Sarah having to sell the farmland in order to pay for her husband’s long term care would be a catastrophe! Medicaid strategies revolve around helping Sarah and John become eligible for Medicaid without having to spend a significant amount of those assets before they are eligible.

Sticking with the theme of extreme simplicity, the strategy is largely about moving the assets in the left column below to the right column, or completely off the grid (Irrevocable Trusts).

Clearly, we need to back up for a second and explain the relevance of the chart below and what this means.

Let’s take Sarah as the example here. Let’s say that in 20 years her husband John goes to the nursing home. Naturally, we do not want them to liquidate the IRAs and/or the farmland in order to pay $100,000 per year (approximate national median cost of private room in today’s dollars) for the nursing home. So, what will she do? She might seek the assistance of Medicaid and fill out the Medicaid application. On that Medicaid application they would ask for all of their assets as well as income sources, including social security.

Medicaid breaks the assets into two different sections. One section is “countable assets“ and the other section is “non-countable assets.“ When I am explaining this to clients, I draw the exact T-Chart that you see. In one column are the countable assets and the other column are the non-countable. The non-countable assets column is the good column. These are the assets where Medicaid has deemed them to be an asset that you should not have to liquidate to pay for your care. Unfortunately, this list is usually small relative to the other column. It is usually items like clothing, household furnishings, the residence, etc. These are assets that you should not have to “spend down” in order to be eligible for Medicaid. I should not have to sell the shirt off my back for Medicaid to kick in. Bad visual I know! Medicaid does not punish you for these assets when it comes to Medicaid eligibility.

Now, the Countable Assets—left column—are the ones they focus on. Countable assets would be checking accounts, IRAs, stocks, bonds, real estate that one is not living in, farmland (in most cases), etc. If John has “countable assets” in today’s dollars over $2,000 (Iowa), he is not eligible for Medicaid. They have to “spend down” their assets in order to become eligible. Keep in mind that the spouse that is not in the nursing home is allowed $137,400 in assets. This is to prevent “spousal impoverishment.” So, what does that mean? It means without proper planning they would have to spend down a large chunk of their $1.5 million in “non-countable assets.” To be exact, they would have to spend down $1,360,600 in assets. That would leave John with his $2,000 and her with her $137,400. This is without discussing Medicaid’s income limitations on John ($2,523 per month), which we will discuss in detail another time. In Sarah and John’s example, it would mean selling farmland and liquidating the IRA.

What strategies can be explored to avoid “Spend Down”?
There are several steps they can take (or should have already taken), but here are a few that one should look at:

• They could have gifted some of their assets to others as the years have gone by. Now, what if Sarah and John gift all of their otherwise “countable assets” to somebody else the day before they apply for Medicaid? Would this make them eligible for Medicaid? Nope. The government has recognized this strategy and therefore has a five-year “lookback” in most states. For veterans, the lookback can be three years. Therefore, in this example, there would be a period of time where Sarah and John would have to pay their own way. This is called a “penalty period.”
• Irrevocable Trusts: This is a great tool for Medicaid planning as it removes the assets from Sarah and John’s ownership. However, the lookback applies here as well. The farmland can be moved to an Irrevocable trust: Note: There are tradeoffs to moving property to an irrevocable trust, which is considered a separate entity from them. Make sure you work with an attorney to understand them. IRA money cannot be moved to an irrevocable trust. You must liquidate the IRA first.
• A Medicaid Compliant Immediate Annuity: This annuity would be for the retirement assets they have put aside. The notion here is, when you take an otherwise “countable asset” and turn it into an income stream (usually to the spouse outside of the nursing home), it becomes exempt from being a “countable asset.” Therefore, the five-year lookback does not apply here. Of the three options I lay out here, this is the “last minute” option as it is not subject to the lookback. Note: Not all immediate annuities are “Medicaid Compliant.” Very few of them are. To be a “Medicaid Compliant Annuity,” there are a handful of requirements that must be met with the annuity. Therefore, the list of these annuities is very small but very effective.

In closing, it is important to note a couple of things:

Medicaid does seek to “recover” what John and Sarah will take from the Medicaid system once they both pass away! Many consumers are not aware of this. Although there are strategies (Irrevocable Trusts) that work as a shield against recovery, it is almost always best that consumers never get on Medicaid in the first place and instead have LTCI to cover the cost. Without tapping into Medicaid, the estate does not have the government coming after them for “recovery.” The long term care products available today are fabulous and have innovated significantly. Plus, when you have the means to pay for long term care yourself, you have choices… One such choice would be to be cared for in your own home versus a nursing home!

Lastly, in this article we merely talked about the assets and the general idea around Medicaid Planning in a greatly simplified way. We did not even get into the maximum income for John to not have to pay the nursing home himself. We also did not speak about single retirees, Miller Trusts, Minimum Monthly Needs Allowance, Funeral Trusts, homes contiguous with farmland, Medicaid Divorces, Veterans, etc. So, if you have any questions or would like my feedback and guidance feel free to reach out.

Since the file and suspend strategy met its demise with The Bipartisan Budget Act of 2015 and the “restricted application“ opportunity has dwindled to almost nothing—again, thanks to The BBA of 2015—many consumers and agents tend to underestimate the Social Security planning strategies that still remain. This underestimation is understood because on the surface Social Security filing seems to have come down to just a timing issue. However, do not mistake the “timing issue“ with ease and simplicity when it comes to helping your clients optimize their Social Security retirement benefits. There is indeed a massive need in helping your clients maximize their Social Security retirement benefits. After all, by consumers making the wrong decisions, it can cost them hundreds of thousands of dollars over their lifetimes.

To demonstrate an example, I will use myself. My dad died at age 62 and his dad died in his late 60s. Cancer runs rampant in the Gipple family. Because of this I probably should not even buy unripened bananas anymore. So, when I ask audiences of consumers when I should file for Social Security retirement benefits, they exclaim, “Age 62!” As many of us know, age 62 is the earliest you can file for SS retirement benefits unless you are a widow or widower. The audience is on the right track because if I were to die at age 63, for example, I would’ve gotten the most money from the Social Security administration by filing at age 62, versus my full retirement age at 67. And certainly by me trying to get the most “delayed retirement credits“ and waiting until age 70 to file, that would seem extremely misguided. However, filing at age 70 is exactly what I am going to do!

Why would I file at age 70 if I believe that I am on the short end of the life expectancy tables? Because, again, there is always more to Social Security than meets the eye. Because I have been the primary breadwinner in the family, my Social Security benefit will be much larger than my wife’s. What that means is, when I pass away—which will certainly be before my wife—she effectively steps into my shoes and inherits the Social Security benefit that I have been receiving. That is her “survivor benefit.“ So, my filing decision is not just about my lifetime, it is also about my spouse’s. That is just one tiny example of how the “timing issue“ is much more complicated than meets the eye.

Another example of the oversimplification of Social Security in the minds of consumers and agents is the fact that many folks believe that the filing ages are “actuarially equivalent“ at life expectancy and it doesn’t really matter when they file.

Before I make a point on this let me step back and explain the options available to the consumer. He/she could generally file for Social Security retirement benefits anytime between age 62 and age 70. Technically, they could file beyond age 70 but the “delayed retirement credits“ only go to age 70. If they file for Social Security at age 62, they get less of a monthly benefit for longer. They get less of a monthly benefit with this strategy because of early filing penalties. However, they get those payments for longer over their lifetime. Another option is they could file for benefits at age 70 and get a higher monthly benefit for a shorter period. The higher monthly benefits are because of the eight percent per year “delayed retirement credits” that the Social Security Administration gives them for delaying their filing. The shorter period is because of the fact that they are closer to their death when they file. And, of course, the client has the option of taking their benefits at any time between age 62 and 70, including their designated “full retirement age.“

Many people believe that all of the age possibilities in which they can file were created to be “actuarially equivalent“ at their life expectancy. It is true that that was the original intent with the way that the early filing penalties and delayed retirement credits were created. However, remember that much of the brackets that determine the benefits were created back in 1983! Have life expectancies changed since then? Absolutely. Furthermore, many of us are either healthier or less healthy than the overall “life expectancy“ that goes into these calculations.

My main point to all of this is, the appropriate time to file for Social Security benefits is specific to each and every one of us. Consumers need your help in finding the optimal time to file and by helping with Social Security planning, you can help your clients capture possibly hundreds of thousands of dollars over their lifetimes that they otherwise would have left on the table.

I have used a couple of very simplified examples above just to demonstrate a point that the Social Security “optimization” opportunities should not be overlooked because of recent legislation. This point is further highlighted once we get into the more complicated items like Social Security taxation, spousal benefits, ex-spousal benefits, widow/widower benefits, staggered filing strategies between both spouses, etc.