Understanding Retirement and Long-Term Care Investments

I’ve often discussed the concept of “buckets” when it comes to managing retirement spending. Essentially, this means organizing your portfolio based on when you expect to spend the money—like having cash set aside for immediate needs, bonds for medium-term expenses, and stocks for long-term growth. This approach has resonated with readers over the years, providing them with a sense of assurance about their retirement strategies. From this idea, I’ve developed several portfolio structures using these retirement buckets.

Interestingly, this “bucket” strategy isn’t just for retirement. Last week, I touched on how to determine spending amounts for those opting not to use insurance. But a key question remains: how should those savings be invested?

Choosing Investments for Long-Term Care

Let’s clarify a few common misconceptions about these buckets. It’s important to note that you don’t need a separate account for each bucket. In fact, a long-term care bucket can be integrated into existing accounts. Usually, if you’re using this system for retirement, your three buckets will span various account types—traditional, tax-advantaged, and taxable accounts.

So, which type of account is the best option for out-of-pocket expenses, particularly when considering tax implications?

A health savings account (HSA) might come to mind as a logical choice. Eligible medical expenses can be withdrawn tax-free from HSAs, including most long-term care costs. However, there are limitations. For instance, annual contribution limits (currently $4,300 for individuals and $8,550 for families) can restrict how much you can save for long-term care, particularly for those over 50. It’s also worth noting that if someone is covered by Medicare, additional HSA contributions won’t be possible. So, while HSAs can be beneficial, they might not accumulate sufficient funds to address the ever-increasing costs of long-term care.

Another concern is that HSAs tend to be overly focused on immediate tax benefits. Costs related to long-term care, combined with other healthcare expenses, can be deducted only if they exceed 7.5% of adjusted gross income. This means you might not be fully leveraging the tax advantages of your HSA when medical deductions are factored in. Finally, if you tap into this long-term care bucket later in life, any remaining funds that go to heirs won’t retain the same tax advantages if the funds are inherited by someone other than your spouse.

To maximize the benefits tied to long-term care deductions, consider withdrawing funds from a traditional IRA, which has different tax implications. Many retirees hold most of their savings in IRAs. Withdrawals from these accounts are generally taxable, but for people incurring significant long-term care expenses, the subsequent deductions could help offset this tax burden. Since most long-term care costs typically arise later in life, you’ll be required to withdraw funds from these accounts anyway, and utilizing the medical expense deduction can ease the tax impact.

Strategies for Long-Term Care Investment

When it comes to deciding how to invest for long-term care, especially if you’re not yet retired (or just recently have), cash alone won’t suffice. Long-term inflation is outpacing general inflation. For instance, according to a recent survey, nursing home costs have inflated between 7% to 9%, which is significant.

Clearly, addressing inflation is crucial for those setting aside funds for long-term care. It’s not just about keeping up with basic inflation; you have to consider the potential for steep future costs associated with long-term care. Therefore, making your money grow means you’ll need to accept some risks.

Much like any other bucket strategy, your timeline to needing these funds should influence your level of risk. If you’re in your mid-60s, for example, data suggests you likely won’t require long-term care for another 15 years. In this phase of life, you have a greater risk capacity, so a growth-oriented portfolio focused on stocks is advisable.

As you move into your mid-70s, you might shift your investment from stocks to a more conservative mix of bonds and cash, particularly as the need for long-term care can arise within the next five to ten years. A balanced asset allocation, like my medium retirement bucket strategy, can serve as a useful guideline. Once you are actively spending from these funds, it becomes essential to adopt a more cautious asset strategy, primarily utilizing bonds and cash.

Of course, investing wisely for long-term care isn’t a precise science. Numerous unknowns can impact how much you should reserve or when you’ll actually need the funds. It’s also risky to assume that your investments will remain adequate until a later date. A practical option for long-term care portfolios is to diversify within various investments, combining bonds and equity assets into a single holding, akin to a moderate growth strategy.