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Medicaid Planning Basics

Medicaid Planning Basics

The best time to plan for the possibility of nursing home care is when you’re still healthy. By doing so, you may be able to pay for your long-term care and preserve assets for your loved ones. How? Through Medicaid planning.

Eligibility for Medicaid depends on your state’s asset and income-level requirements

Medicaid is a joint federal-state program that provides medical assistance to various low-income individuals, including those who are aged (i.e., 65 or older), disabled, or blind. It is the single largest payer of nursing home bills in America and is the last resort for people who have no other way to finance their long-term care. Although Medicaid eligibility rules vary from state to state, federal minimum standards and guidelines must be observed.

In addition to you meeting your state’s medical and functional criteria for nursing home care, your assets and monthly income must each fall below certain levels if you are to qualify for Medicaid. However, several assets (which may include your family home) and a certain amount of income may be exempt or not counted.

Medicaid planning can help you meet your state’s requirements

To determine whether you qualify for Medicaid, your state may count only the income and assets that are legally available to you for paying bills. That’s where Medicaid planning comes in. Over the years, a number of tools and strategies have arisen that might help you qualify for Medicaid sooner.

In general, Medicaid planning seeks to accomplish the following goals:

  • Exchanging countable assets for exempt assets to help you meet Medicaid eligibility requirements
  • Preserving assets for your loved ones
  • Providing for your healthy spouse (if you’re married)

Let’s look at these in turn.

You may be able to exchange countable assets for exempt assets

Countable assets are those that are not exempt by state law or otherwise made inaccessible to the state for Medicaid purposes. The total value of your countable assets (together with your countable income) will determine your eligibility for Medicaid. Under federal guidelines, each state compiles a list of exempt assets. Usually, this list includes such items as the family home (regardless of value), prepaid burial plots and contracts, one automobile, and term life insurance.

Through Medicaid planning, you may be able to rearrange your finances so that countable assets are exchanged for exempt assets or otherwise made inaccessible to the state. For example, you may be able to pay off the mortgage on your family home, make home improvements and repairs, pay off your debts, purchase a car for your healthy spouse, and prepay burial expenses.

For more information on this topic, contact an elder law attorney who is experienced with your state’s Medicaid laws.

Irrevocable trusts can help you leave something for your loved ones

Why not simply liquidate all of your assets to pay for your nursing home care? After all, Medicaid will eventually kick in (in most states) once you’ve exhausted your personal resources. The reason is simple: You want to assist your loved ones financially.

There are many ways to potentially preserve assets for your loved ones. One way is to use an irrevocable trust. (It’s irrevocable in the sense that you can’t later change its terms or decide to end it.) Property placed in an irrevocable trust will be excluded from your financial picture, for Medicaid purposes. If you name a proper beneficiary, the principal that you deposit into the trust (and possibly any income generated) will be sheltered from the state and can be preserved for your heirs. Typically, though, the trust must be in place and funded for a specific period of time for this strategy to be an effective Medicaid planning tool.

For information about Medicaid planning trusts, consult an experienced attorney.

If you’re married, an annuity can help you provide for your healthy spouse

Nursing homes are expensive. If you must go to one, will your spouse have enough money to live on? With a little planning, the answer is yes. Here’s how Medicaid affects a married couple. A couple’s assets are pooled together when the state is considering the eligibility of one spouse for Medicaid. The healthy spouse is entitled to keep a spousal resource allowance that generally amounts to one-half of the assets. This may not amount to much money over the long term.

A healthy spouse may want to use jointly owned, countable assets to buy a single premium immediate annuity to benefit himself or herself. Converting countable assets into an income stream is a plus because each spouse is entitled to keep all of his or her own income, in contrast to the pooling of assets. By purchasing an immediate annuity in this manner, the institutionalized spouse can more easily qualify for Medicaid, and the healthy spouse can enjoy a higher standard of living.

Be aware, however, that for annuities purchased on February 8, 2006 and thereafter (the date of enactment of the Deficit Reduction Act of 2005), the state must be named as the remainder beneficiary of the annuity after your spouse or a minor or disabled child.

Beware of certain Medicaid planning risks

Medicaid planning is not without certain risks and drawbacks. In particular, you should be aware of look-back periods, possible disqualification for Medicaid, and estate recoveries.

When you apply for Medicaid, the state has the right to review, or look back, at your finances (and those of your spouse) for a period of months before the date you applied for assistance. In general, a 60-month look-back period exists for transfers of countable assets for less than fair market value. Transfers of countable assets for less than fair market value made during the look-back period will usually result in a waiting period before you can start to collect Medicaid. So, for example, if you give your house to your kids the year before you enter a nursing home, you’ll be ineligible for Medicaid for quite some time. (A mathematical formula is used.)

Also, you should know that Medicaid planning is more effective in some states than in others. In addition, federal law encourages states to seek reimbursement from Medicaid recipients for Medicaid payments made on their behalf. This means that your state may be able to place a lien on your property while you are alive, or seek reimbursement from your estate after you die. Make sure to consult an attorney experienced with Medicaid planning and the laws in your state before taking any action.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Understanding Undefined Benefit Plans

Understanding Undefined Benefit Plans

You may be counting on funds from a defined benefit plan to help you achieve a comfortable retirement. Often referred to as traditional pension plans, defined benefit plans promise to pay you a specified amount at retirement.

To help you understand the role a defined benefit plan might play in your retirement savings strategy, here’s a look at some basic plan attributes. But since every employer’s plan is a little different, you’ll need to read the summary plan description, or SPD, provided by your company to find out the details of your own plan.

What are defined benefit plans?

Defined benefit plans are qualified employer-sponsored retirement plans. Like other qualified plans, they offer tax incentives both to employers and to participating employees. For example, your employer can generally deduct contributions made to the plan. And you generally won’t owe tax on those contributions until you begin receiving distributions from the plan (usually during retirement). However, these tax incentives come with strings attached–all qualified plans. This is including defined benefit plans, must comply with a complex set of rules under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code.

How do defined benefit plans work?

A defined benefit plan guarantees you a certain benefit when you retire. How much you receive generally depends on factors such as your salary, age, and years of service with the company.

Each year, pension actuaries calculate the future benefits that are projected to be paid from the plan. Ultimately, this determines what amount, if any, needs to be contributed to the plan to fund that projected benefit payout. Employers are normally the only contributors to the plan. But defined benefit plans can require that employees contribute to the plan, although it’s uncommon.

You may have to work for a specific number of years before you have a permanent right to any retirement benefit under a plan. This is generally referred to as “vesting.” If you leave your job before you fully vest in an employer’s defined benefit plan, you won’t get full retirement benefits from the plan.

How are retirement benefits calculated?

Retirement benefits under a defined benefit plan are based on a formula. This formula can provide for a set dollar amount for each year you work for the employer. Or it can provide for a specified percentage of earnings. Many plans calculate an employee’s retirement benefit by averaging the employee’s earnings during the last few years of employment (or, alternatively, averaging an employee’s earnings for his or her entire career), taking a specified percentage of the average, and then multiplying it by the employee’s number of years of service.

Note: Many defined benefit pension plan formulas also reduce pension benefits by a percentage of the amount of Social Security benefits you can expect to receive.

How will retirement benefits be paid?

Many defined benefit plans allow you to choose how you want your benefits to be paid. Payment options commonly offered include:

  • A single life annuity: You receive a fixed monthly benefit until you die; after you die, no further payments are made to your survivors.
  • A qualified joint and survivor annuity: You receive a fixed monthly benefit until you die; after you die, your surviving spouse will continue to receive benefits (in an amount equal to at least 50 percent of your benefit) until his or her death.
  • A lump-sum payment: You receive the entire value of your plan in a lump sum; no further payments will be made to you or your survivors.

Choosing the right payment option is important, because the option you choose can affect the amount of benefit you ultimately receive. You’ll want to consider all of your options carefully, and compare the benefit payment amounts under each option. Because so much may hinge on this decision, you may want to discuss your options with a financial advisor.

What are some advantages offered by defined benefit plans?

  • Defined benefit plans can be a major source of retirement income. They’re generally designed to replace a certain percentage (e.g., 70 percent) of your preretirement income when combined with Social Security.
  • Benefits do not hinge on the performance of underlying investments, so you know ahead of time how much you can expect to receive at retirement.
  • Most benefits are insured up to a certain annual maximum by the federal government through the Pension Benefit Guaranty Corporation (PBGC).

How do defined benefit plans differ from defined contribution plans?

Though it’s easy to do, don’t confuse a defined benefit plan with another type of qualified retirement plan, the defined contribution plan (e.g., 401(k) plan, profit-sharing plan). As the name implies, a defined benefit plan focuses on the ultimate benefits paid out. Your employer promises to pay you a certain amount at retirement and is responsible for making sure that there are enough funds in the plan to eventually pay out this amount, even if plan investments don’t perform well.

In contrast, defined contribution plans focus primarily on current contributions made to the plan. Your plan specifies the contribution amount you’re entitled to each year (contributions made by either you or your employer), but your employer is not obligated to pay you a specified amount at retirement. Instead, the amount you receive at retirement will depend on the investments you choose and how those investments perform.

Some employers offer hybrid plans. Hybrid plans include defined benefit plans that have many of the characteristics of defined contribution plans. One of the most popular forms of a hybrid plan is the cash balance plan.

What are cash balance plans?

Cash balance plans are defined benefit plans that in many ways resemble defined contribution plans. Like defined benefit plans, they are obligated to pay you a specified amount at retirement, and are insured by the federal government. But they also offer one of the most familiar features of a defined contribution plan: Retirement funds accumulate in an individual account (in this case, a hypothetical account).

This allows you to easily track how much retirement benefit you have accrued. And your benefit is portable. If you leave your employer, you can generally opt to receive a lump-sum distribution of your vested account balance. These funds can be rolled over to an individual retirement account (IRA) or to your new employer’s retirement plan.

What you should do now

It’s never too early to start planning for retirement. Your pension income, along with Social Security, personal savings, and investment income, can help you realize your dream of living well in retirement.

Start by finding out how much you can expect to receive from your defined benefit plan when you retire. Your employer will send you this information every year. But read the fine print. Estimates often assume that you’ll retire at age 65 with a single life annuity. Your monthly benefit could end up to be far less if you retire early or receive a joint and survivor annuity. Finally, remember that most defined benefit plans don’t offer cost-of-living adjustments, so benefits that seem generous now may be worth a lot less in the future when inflation takes its toll.

Here are some other things you can do to make the most of your defined benefit plan:

  • Read the summary plan description. It provides details about your company’s pension plan and includes important information, such as vesting requirements and payment options.
  • Address questions to your plan administrator if there’s anything you don’t understand.
  • Review your account information, making sure you know what benefits you are entitled to. Do this periodically, checking your Social Security number, date of birth, and the compensation used to calculate your benefits, since these are common sources of error.
  • Notify your plan administrator of any life changes that may affect your benefits (e.g., marriage, divorce, death of spouse).
  • Keep track of the pension information for each company you’ve worked for. Make sure you have copies of pension plan statements that accurately reflect the amount of benefits you’re entitled to receive.
  • Watch out for changes. Employers are allowed to change and even terminate pension plans, but you will receive ample notice. The key is, read all notices you receive.
  • Assess the impact of changing jobs on your pension. Consider staying with one employer at least until you’re vested. Keep in mind that the longer you stay with one employer, the more you’re likely to receive at retirement.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

The Roth 401(k)

The Roth 401(k)

Employers can offer 401(k) plan participants the opportunity to make Roth 401(k) contributions. If you’re lucky enough to work for an employer who offers this option, Roth contributions could play an important role in maximizing your retirement income.

What is a Roth 401(k)?

A Roth 401(k) is simply a traditional 401(k) plan that accepts Roth 401(k) contributions. Roth 401(k) contributions are made on an after-tax basis, just like Roth IRA contributions. This means there’s no up-front tax benefit, but if certain conditions are met, your Roth 401(k) contributions and all accumulated investment earnings on those contributions are free from federal income tax when distributed from the plan. [403(b) and 457(b) plans can also allow Roth contributions.]

Who can contribute?

Unlike Roth IRAs, where you can’t contribute if you earn more than a certain dollar amount, you can make Roth contributions, regardless of your salary level, as soon as you are eligible to participate in the 401(k) plan. And while a 401(k) plan can require employees to wait up to one year before they become eligible to contribute, many plans allow you to contribute beginning with your first paycheck.

How much can I contribute?

There’s an overall cap on your combined pre-tax and Roth 401(k) contributions. In 2020, you can contribute up to $19,500 ($26,000 if you’re age 50 or older) to a 401(k) plan. You can split your contribution between Roth and pre-tax contributions any way you wish. For example, you can make $10,000 of Roth contributions and $9,500 of pre-tax 401(k) contributions. It’s up to you. But keep in mind that if you also contribute to another employer’s 401(k), 403(b), SIMPLE, or SAR-SEP plan, your total contributions to all of these plans — both pre-tax and Roth — can’t exceed $19,500 in 2020 ($26,000 if you’re age 50 or older). It’s up to you to make sure you don’t exceed these limits if you contribute to plans of more than one employer.

Can I also contribute to an IRA?

Yes. Your participation in a 401(k) plan has no impact on your ability to contribute to an IRA (Roth or traditional). You can contribute up to $6,000 to an IRA in 2020 ($7,000 if you’re age 50 or older). Your ability to contribute to a Roth IRA may be limited if your “modified adjusted gross income” (MAGI) exceeds certain levels. Similarly, your ability to make deductible contributions to a traditional IRA may be limited if your MAGI exceeds certain levels and you (or your spouse) participate in a 401(k) plan.

Are distributions really tax free?

Because your Roth 401(k) contributions are made on an after-tax basis, they’re always free from federal income tax when distributed from the plan. Investment earnings on your Roth contributions are tax free if you meet the requirements for a “qualified distribution.”

In general, a distribution from your Roth 401(k) account is qualified if it satisfies both of the following requirements:

It’s made after the end of a five-year waiting period

The payment is made after you turn 59½, become disabled, or die

The five-year waiting period for qualified distributions starts on January 1 of the year you make your first Roth contribution to the 401(k) plan. For example, if you make your first Roth contribution to your employer’s 401(k) plan in December 2020, your five-year waiting period begins January 1, 2020, and ends on December 31, 2024. If you participate in more than one Roth 401(k) plan, your five-year waiting period is generally determined separately for each employer’s plan. But if you change employers and directly roll over your Roth 401(k) account from your prior employer’s plan to your new employer’s Roth 401(k) plan (assuming the new plan accepts rollovers), the five-year waiting period for your new plan starts instead with the year you made your first contribution to the earlier plan.

If your distribution isn’t qualified (for example, if you receive a payout before the five-year waiting period has elapsed), the portion of your distribution that represents investment earnings on your Roth contributions will be taxable, and will be subject to a 10% early distribution penalty unless you’re 59½ (55 in some cases) or another exception applies. You can generally avoid taxation by rolling all or part of your distribution over into a Roth IRA or into another employer’s Roth 401(k) or 403(b) plan, if that plan accepts Roth rollovers. [State income tax treatment of Roth 401(k) contributions may differ from the federal rules.]

If you contribute to both a Roth 401(k) and a Roth IRA, a separate five-year waiting period applies to each. Your Roth IRA five-year waiting period begins with the first year that you make a regular or rollover contribution to any Roth IRA.

Due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, penalty-free withdrawals of up to $100,000 may be allowed in 2020 for qualified individuals affected by COVID-19. Individuals will be able to spread the associated income over three years for income tax purposes and will have up to three years to reinvest withdrawn amounts.

What about employer contributions?

Employers don’t have to contribute to 401(k) plans, but many will match all or part of your contributions. Your employer can match your Roth contributions, your pre-tax contributions, or both. But your employer’s contributions are always made on a pre-tax basis, even if they match your Roth contributions. That is, your employer’s contributions, and investment earnings on those contributions, are not taxed until you receive a distribution from the plan. Your 401(k) plan may require up to six years of service before you fully own employer matching contributions. [Note: If your plan is a SIMPLE 401(k) plan, a safe-harbor 401(k) plan, or includes a qualified automatic contribution arrangement (QACA) your employer is required to make a contribution on your behalf, and special vesting rules apply.]

Should I make pre-tax or Roth 401(k) contributions?

When you make pre-tax 401(k) contributions, you don’t pay current income taxes on those dollars (which means more take-home pay compared to an after-tax Roth contribution of the same amount). But your contributions and investment earnings are fully taxable when you receive a distribution from the plan. In contrast, Roth 401(k) contributions are subject to income taxes up front, but qualified distributions of your contributions and earnings are entirely free from federal income tax.

Which is the better option depends upon your personal situation. If you think you’ll be in a similar or higher tax bracket when you retire, Roth 401(k) contributions may be more appealing, since you’ll effectively lock in today’s lower tax rates. However, if you think you’ll be in a lower tax bracket when you retire, pre-tax 401(k) contributions may be more appropriate. Your investment horizon and projected investment results are also important factors. A financial professional can help you determine which course is best for you.

Whichever you choose — Roth or pre-tax — make sure you contribute as much as necessary to get the maximum matching contribution from your employer. This is essentially free money that can help you pursue your retirement goals.

What happens when I terminate employment?

When you terminate employment, you generally forfeit all employer contributions (and earnings on them) that haven’t vested. “Vesting” means that you own the contributions and any associated earnings. Your contributions, Roth and pre-tax, are always 100% vested. But your 401(k) plan may require up to six years of service before you fully vest in employer matching contributions (although some plans have a much faster vesting schedule).

When you terminate employment, you can generally leave your money in your 401(k) plan, although some plans require that you withdraw your funds when you reach the plan’s normal retirement age (typically age 65). (You generally must begin taking distributions after you reach age 72.1) Your plan may also “cash you out” if your vested balance is $5,000 or less, but if your payment is more than $1,000, the plan must generally roll your funds into an IRA established on your behalf, unless you elect to receive your payment in cash. [This $1,000 limit is determined separately for your Roth 401(k) account and the rest of your funds in the 401(k) plan.]

You can also roll all or part of your Roth 401(k) dollars over to a Roth IRA, and your non-Roth dollars to a traditional IRA. You may also be able to convert your non-Roth dollars to a Roth IRA, but income taxes will apply to any tax-deferred amounts in the year of conversion. You may also be able to roll your funds into another employer’s plans that accepts rollovers.

Finally, you may also be able to take a cash distribution of your contributions and earnings, as well as any vested employer amounts. However, keep in mind that any tax-deferred funds will be subject to income taxes and a possible 10% penalty tax if you’re under age 59½ and an exception does not apply. (As noted above, an exception to the penalty tax may be allowed in 2020 for qualified participants affected by the coronavirus for distributions up to $100,000.)

When considering a rollover, to either an IRA or to another employer’s retirement plan, you should consider carefully the investment options, fees and expenses, services, ability to make penalty-free withdrawals, degree of creditor protection, and distribution requirements associated with each option.

What else do I need to know?

Like pre-tax 401(k) contributions, your Roth 401(k) contributions and investment earnings can generally be paid from the plan only after you terminate employment, attain age 59½, become disabled, or die.

You may be eligible to borrow up to one half of your vested 401(k) account, including your Roth contributions, (to a maximum of $50,000) if you need the money. Due to the CARES Act, loans of up to 100,000 or 100% of your vested account balance may be allowed between March 27, 2020, and September 22, 2020.

You may be able to take a hardship withdrawal if you (or your spouse, dependents, or primary beneficiary) have an immediate and heavy financial need. But this should be a last resort — hardship distributions are generally taxable to you and a 10% penalty may apply to the taxable amount if you’re not yet age 59½.

Unlike Roth IRAs, you must begin taking distributions from a Roth 401(k) plan after you reach age 72 (or in some cases, after you retire), but you can generally roll over your Roth 401(k) dollars into a Roth IRA if you don’t need or want the lifetime distributions.1

Distributions from your plan before you turn 59½ (55 in some cases) may be subject to a 10% early distribution penalty unless an exception applies.

Depending on your income, you may be eligible for an income tax credit of up to $1,000 for amounts you contribute to the 401(k) plan.

Your assets are generally fully protected from creditors.

Employers aren’t required to make Roth contributions available in their 401(k) plans. So be sure to ask your employer if they are considering adding this exciting new feature to your 401(k) plan.

1Due to the CARES Act, required minimum distributions (RMDs) are waived in 2020.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Medicaid and the Principal Residence

Medicaid and the Principal Residence

Although your stay can be paid for by your personal savings or by your long-term care insurance policy (if you have one), many nursing home residents end up using Medicaid (a joint federal-state program for low-income individuals) to pay for their care. Unfortunately, if you’re a Medicaid beneficiary, your state may be able to attach a lien to your house while you’re living or after you die. To preserve the home for your family, you should plan for Medicaid well in advance of your nursing home stay. If you’re like most homeowners, your principal residence is one of your most valuable assets. It may have sentimental value, and it may also represent financial security for your loved ones. If a nursing home stay lies in your future, though, the skyrocketing cost of long-term care can jeopardize your house and deplete your other assets.

Medicaid and the treatment of your home during your lifetime

If you want to qualify for Medicaid benefits, you must generally have very limited income and few assets. But several assets, including your family home, may be exempt or not counted toward your Medicaid eligibility. Your house is exempt as long as you live in it. It’s also exempt if your spouse, your minor child, or your disabled or blind child lives in your home after you become a permanent nursing home resident.

However, assets that are exempt for the purpose of determining Medicaid eligibility can still be attached to reimburse the state for its costs. The federal government encourages states to seek reimbursement from Medicaid recipients for Medicaid payments made on their behalf. To this end, federal law allows a lien to be placed on your home at the time you become a permanent resident of a nursing home. (A Medicaid lien makes it impossible for you to sell your home or refinance your mortgage without paying the state whatever may be owed.) But not all states have adopted laws providing for such liens. Even if your state has adopted such a law, a Medicaid lien can’t be imposed on your home during your lifetime while specified relatives (such as your spouse) lawfully live there.

Medicaid and the treatment of your home after your death

Your state may be able to seek reimbursement for Medicaid benefits from your estate after you die. For Medicaid purposes, the word estate has traditionally meant your probate estate (i.e., the property that passes under your will, rather than by operation of law). States have the option, though, to expand the definition of estate to include all nonprobate assets as well (to the extent of a Medicaid recipient’s legal interest in those assets). If you’re interested in Medicaid planning, you should consult an experienced attorney to learn whether your state has adopted an expanded definition.

Your state cannot enforce a lien or attempt estate recovery procedures until after the deaths of your surviving spouse (if you have one) and certain other specified relatives. The same holds true while specified individuals lawfully live in your home.

Be careful: Medicaid planning strategies can impact your eligibility for Medicaid benefits

If you want to qualify for Medicaid and also preserve your family home, consider transferring your home to family members. Be sure you do this well in advance of your nursing home entry, though. If you transfer your home for less than its fair market value within 60 months (the new look-back period under federal law) of the time you apply for Medicaid as a nursing home resident, you may be ineligible to qualify for Medicaid for a period of months, based on a formula set by your state. (For transfers made prior to February 8, 2006, the look-back period is 36 months, or 60 months if the home was transferred to an irrevocable trust.)

If you have time to plan, you should consider the following ways to protect your home.

Gift the house to a loved one

While you’re alive, consider making a gift of your home to your children or other loved ones. This will remove the house from your financial picture entirely, assuming the gift is completed more than 60 months (or the applicable look-back period) before you apply for Medicaid. Your state cannot place a lien or force a sale on a home that no longer belongs to you and is not part of your estate. Unfortunately, this strategy may involve gift tax consequences and has income tax repercussions. Also, you’ll give up your legal right to live in the home, so you’ll be affected by the decisions made by your children and their spouses.

Transfer your home into an irrevocable trust

You can transfer your home into an irrevocable income-only trust, but the effectiveness of this strategy depends on the laws of your state. An irrevocable trust cannot be altered in any way. With the income-only version, you are entitled to receive only the income (if any) that the trust generates. A transfer into this form of trust will remove the house from your probate estate. However, your state may seek reimbursement after your death if it has adopted an expanded definition of estate. Still, it will be able to collect only the present value of your income interest at the moment before your death.

Transfer the home, but reserve a life estate for yourself

Here, you’d transfer the remainder interest in your house to your loved ones but keep a life estate for yourself. This means that you’d have the legal right to live in the house during your lifetime. Only the value of the life estate is treated as a countable asset for Medicaid eligibility purposes, and any period of ineligibility is shortened. After your death, the entire value of the residence would be subject to estate taxes, but your children would own the home automatically and receive a stepped-up tax basis. (That is, the basis of the property would be its fair market value at the time of your death.) On the downside, if your state has adopted an expanded definition of estate, it may be able to force a sale of the property after your death, collecting the value of your life estate at the moment before your death.

Transfer the home subject to a special power of appointment

With a special power of appointment, you’d transfer the ownership of your house to someone else, while reserving your right to redirect the house to a different person at a later time. You could exercise this power during your lifetime (by a deed) or at your death (by a will), subject to certain limitations. With this tool, your state would be unable to go after the house (either during your lifetime or after your death). However, you’d lose the legal right to live in the house.

Obviously, Medicaid planning is complicated. There are several other strategies available to protect your home, and you’ll want to explore all of your options. For more information, be sure to consult an elder law attorney who has experience with your state’s Medicaid laws.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Retirement Planning: The Basics

Retirement Planning: The Basics

You may have a very idealistic vision of retirement–doing all of the things that you never seem to have time to do now. But how do you pursue that vision? Social Security may be around when you retire, but the benefit that you get from Uncle Sam may not provide enough income for your retirement years. To make matters worse, few employers today offer a traditional company pension plan that guarantees you a specific income at retirement. On top of that, people are living longer and must find ways to fund those additional years of retirement. Such eye-opening facts mean that today, sound retirement planning is critical.

But there’s good news: Retirement planning is easier than it used to be, thanks to the many tools and resources available. Here are some basic steps to get you started.

Determine your retirement income needs

It’s common to discuss desired annual retirement income as a percentage of your current income. Depending on who you’re talking to, that percentage could be anywhere from 60 to 90 percent, or even more. The appeal of this approach lies in its simplicity. The problem, however, is that it doesn’t account for your specific situation. To determine your specific needs, you may want to estimate your annual retirement expenses.

Use your current expenses as a starting point, but note that your expenses may change dramatically by the time you retire. If you’re nearing retirement, the gap between your current expenses and your retirement expenses may be small. If retirement is many years away, the gap may be significant, and projecting your future expenses may be more difficult.

Remember to take inflation into account. The average annual rate of inflation over the past 20 years has been approximately 3 percent. (Source: Consumer price index (CPI-U) data published annually by the U.S. Department of Labor.) And keep in mind that your annual expenses may fluctuate throughout retirement. For instance, if you own a home and are paying a mortgage, your expenses will drop if the mortgage is paid off by the time you retire. Other expenses, such as health-related expenses, may increase in your later retirement years. A realistic estimate of your expenses will tell you about how much yearly income you’ll need to live comfortably.

Calculate the gap

Once you have estimated your retirement income needs, take stock of your estimated future assets and income. These may come from Social Security, a retirement plan at work, a part-time job, and other sources. If estimates show that your future assets and income will fall short of what you need, the rest will have to come from additional personal retirement savings.

Figure out how much you’ll need to save

By the time you retire, you’ll need a nest egg that will provide you with enough income to fill the gap left by your other income sources. But exactly how much is enough? The following questions may help you find the answer:

  • At what age do you plan to retire? The younger you retire, the longer your retirement will be, and the more money you’ll need to carry you through it.
  • What is your life expectancy? The longer you live, the more years of retirement you’ll have to fund.
  • What rate of growth can you expect from your savings now and during retirement? Be conservative when projecting rates of return.
  • Do you expect to dip into your principal? If so, you may deplete your savings faster than if you just live off investment earnings. Build in a cushion to guard against these risks.

Build your retirement fund: Save, save, save

When you know roughly how much money you’ll need, your next goal is to save that amount. First, you’ll have to map out a savings plan that works for you. Assume a conservative rate of return (e.g., 5 to 6 percent), and then determine approximately how much you’ll need to save every year between now and your retirement to reach your goal.

The next step is to put your savings plan into action. It’s never too early to get started (ideally, begin saving in your 20s). To the extent possible, you may want to arrange to have certain amounts taken directly from your paycheck and automatically invested in accounts of your choice (e.g., 401(k) plans, payroll deduction savings). This arrangement reduces the risk of impulsive or unwise spending that will threaten your savings plan–out of sight, out of mind. If possible, save more than you think you’ll need to provide a cushion.

Understand your investment options

You need to understand the types of investments that are available, and decide which ones are right for you. If you don’t have the time, energy, or inclination to do this yourself, hire a financial professional. He or she will explain the options that are available to you, and will assist you in selecting investments that are appropriate for your goals, risk tolerance, and time horizon.

Use the right savings tools

The following are among the most common retirement savings tools, but others are also available.

Employer-sponsored retirement plans that allow employee deferrals (like 401(k), 403(b), SIMPLE, and 457(b) plans) are powerful savings tools. Your contributions come out of your salary as pretax contributions (reducing your current taxable income) and any investment earnings are tax deferred until withdrawn. These plans often include employer-matching contributions and should be your first choice when it comes to saving for retirement. Both 401(k) and 403(b) plans can also allow after-tax Roth contributions. While Roth contributions don’t offer an immediate tax benefit, qualified distributions from your Roth account are federal income tax free.

IRAs, like employer-sponsored retirement plans, feature tax deferral of earnings. If you are eligible, traditional IRAs may enable you to lower your current taxable income through deductible contributions. Withdrawals, however, are taxable as ordinary income (unless you’ve made nondeductible contributions, in which case a portion of the withdrawals will not be taxable).

Roth IRAs don’t permit tax-deductible contributions but allow you to make completely tax-free withdrawals under certain conditions. With both types, you can typically choose from a wide range of investments to fund your IRA.

Annuities are generally funded with after-tax dollars, but their earnings are tax deferred (you pay tax on the portion of distributions that represents earnings). There is generally no annual limit on contributions to an annuity. A typical annuity provides income payments beginning at some future time, usually retirement. The payments may last for your life, for the joint life of you and a beneficiary, or for a specified number of years (guarantees are subject to the claims-paying ability of the issuing insurance company).

Note: In addition to any income taxes owed, a 10 percent premature distribution penalty tax may apply to distributions made from employer-sponsored retirement plans, IRAs, and annuities prior to age 59½ (prior to age 55 for employer-sponsored retirement plans in some circumstances).

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Saving for Retirement and a Child’s Education at the Same Time

Saving for Retirement and a Child’s Education at the Same Time

You want to retire comfortably when the time comes. You also want to help your child go to college. So how do you juggle the two? The truth is, saving for your retirement and your child’s education at the same time can be a challenge. But take heart–you may be able to reach both goals if you make some smart choices now.

Know what your financial needs are

The first step is to determine what your financial needs are for each goal. Answering the following questions can help you get started:

For retirement:

  • How many years until you retire?
  • Does your company offer an employer-sponsored retirement plan or a pension plan? Do you participate? If so, what’s your balance? Can you estimate what your balance will be when you retire?
  • How much do you expect to receive in Social Security benefits? (You can estimate this amount by using your Personal Earnings and Benefit Statement, now mailed every year by the Social Security Administration.)
  • What standard of living do you hope to have in retirement? For example, do you want to travel extensively, or will you be happy to stay in one place and live more simply?
  • Do you or your spouse expect to work part-time in retirement?

For college:

  • How many years until your child starts college?
  • Will your child attend a public or private college? What’s the expected cost?
  • Do you have more than one child whom you’ll be saving for?
  • Does your child have any special academic, athletic, or artistic skills that could lead to a scholarship?
  • Do you expect your child to qualify for financial aid?

Many on-line calculators are available to help you predict your retirement income needs and your child’s college funding needs.

Figure out what you can afford to put aside each month

After you know what your financial needs are, the next step is to determine what you can afford to put aside each month. To do so, you’ll need to prepare a detailed family budget that lists all of your income and expenses. Keep in mind, though, that the amount you can afford may change from time to time as your circumstances change. Once you’ve come up with a dollar amount, you’ll need to decide how to divvy up your funds.

Retirement takes priority

Though college is certainly an important goal, you should probably focus on your retirement if you have limited funds. With generous corporate pensions mostly a thing of the past, the burden is primarily on you to fund your retirement. But if you wait until your child is in college to start saving, you’ll miss out on years of tax-deferred growth and compounding of your money. Remember, your child can always attend college by taking out loans (or maybe even with scholarships), but there’s no such thing as a retirement loan!

If possible, save for your retirement and your child’s college at the same time

Ideally, you’ll want to try to pursue both goals at the same time. The more money you can squirrel away for college bills now, the less money you or your child will need to borrow later. Even if you can allocate only a small amount to your child’s college fund, say $50 or $100 a month, you might be surprised at how much you can accumulate over many years. For example, if you saved $100 every month and earned 8 percent, you’d have $18,415 in your child’s college fund after 10 years. (This example is for illustrative purposes only and does not represent a specific investment.)

If you’re unsure how to allocate your funds between retirement and college, a professional financial planner may be able to help you. This person can also help you select the best investments for each goal. Remember, just because you’re pursuing both goals at the same time doesn’t necessarily mean that the same investments will be appropriate. Each goal should be treated independently.

Help! I can’t meet both goals

If the numbers say that you can’t afford to educate your child or retire with the lifestyle you expected, you’ll have to make some sacrifices. Here are some things you can do:

  • Defer retirement: The longer you work, the more money you’ll earn and the later you’ll need to dip into your retirement savings.
  • Work part-time during retirement.
  • Reduce your standard of living now or in retirement: You might be able to adjust your spending habits now in order to have money later. Or, you may want to consider cutting back in retirement.
  • Increase your earnings now: You might consider increasing your hours at your current job, finding another job with better pay, taking a second job, or having a previously stay-at-home spouse return to the workforce.
  • Invest more aggressively: If you have several years until retirement or college, you might be able to earn more money by investing more aggressively (but remember that aggressive investments mean a greater risk of loss).
  • Expect your child to contribute more money to college: Despite your best efforts, your child may need to take out student loans or work part-time to earn money for college.
  • Send your child to a less expensive school: You may have dreamed your child would follow in your footsteps and attend an Ivy League school. However, unless your child is awarded a scholarship, you may need to lower your expectations. Don’t feel guilty–a lesser-known liberal arts college or a state university may provide your child with a similar quality education at a far lower cost.
  • Think of other creative ways to reduce education costs: Your child could attend a local college and live at home to save on room and board, enroll in an accelerated program to graduate in three years instead for four, take advantage of a cooperative education where paid internships alternate with course work, or defer college for a year or two and work to earn money for college.

Can retirement accounts be used to save for college?

Yes. Should they be? Probably not. Most financial planners discourage paying for college with funds from a retirement account; they also discourage using retirement funds for a child’s college education if doing so will leave you with no funds in your retirement years. However, you can certainly tap your retirement accounts to help pay the college bills if you need to. With IRAs, you can withdraw money penalty free for college expenses, even if you’re under age 59½ (though there may be income tax consequences for the money you withdraw). But with an employer-sponsored retirement plan like a 401(k) or 403(b), you’ll generally pay a 10 percent penalty on any withdrawals made before you reach age 59½ (age 55 in some cases), even if the money is used for college expenses. You may also be subject to a six month suspension if you make a hardship withdrawal. There may be income tax consequences, as well.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.