In this video we look at an example of what the tax impact could be if someone were to withdraw a substantial amount of money from an IRA to pay for long term care.
Many people, if not most people, that have done a great job of saving for retirement have most of their money saved in pre-tax retirement accounts.
I will share why having to withdraw a substantial amount of money from a pre-tax retirement account may not cause you to have to pay as much in taxes as you might expect.
In short it's because you can itemize and in this video I show an example of how this works.
When thinking about how you are going to pay for long term care, if you end up needing care at some point, it's important to understand what your options are and the impact your decisions will have on your overall retirement plan.
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Full Transcript:
(00:01):
I am going to share an example of what it might look like if you had to pay for long-term care expenses from the money that's in your IRA. So recently I've been working with a lady, she's recently retired, she's now 67 years old. Like a lot of retirees that have done a great job of saving most of her money is now in pre-tax retirement accounts. And at one point in our discussions, we were talking about long-term care and she commented that if she did need long-term care that she would probably just get killed in taxes. And I mentioned to her that no, that probably wouldn't be the case because you could itemize and she didn't understand really what the impact would be or how that might look. I shared that with her and I also want to share that here with you in case you have any questions about this because this I feel is so important in the case with this lady in particular.
(00:52):
I think in the past she was led to believe that if she needed long-term care, that her IRA would just be crushed. And it's not to say that couldn't happen to somebody. It depends on how much you might actually have in savings in your IRA, but I think it was kind of told to her as a way to make her feel like she needed to buy long-term care insurance. And that would be the only solution. And I'm not saying that long-term care insurance isn't a good tool to have for some people it absolutely is. It's just another tool in the toolkit, so to speak. But it's important to understand the facts and how these things work and when doing, planning for retirement and understanding taxes and all these types of things. Let's go ahead and dive in. I'll share a real quick example with you and show you how this works if she were to itemize in a year that she needed long-term care expenses.
(01:42):
So first of all, we'll take a look at a year in which she does not need long-term care. So we'll say here, 2024, she doesn't need long-term care and these aren't her numbers. I just made up some sample figures here just for our purposes. So let's say this person has $36,000 in Social Security benefits here. They've got $113,000 coming in from an IRA, so their total AGI, because not all the Social Security is subject to tax is $143,000. So on the federal level, which by the way, we're only looking at this on the federal level, I want to keep this simple. And in fact I'm just going to assume here that she lives in a state that doesn't even have state income tax. So down here you'll see $23,000 is the total amount of tax. Now pay attention right here to this. She's right now taking the standard deduction, she doesn't have enough itemized deductions for her to itemize. So she just takes the standard deduction. But now let's say next year, she did need long-term care. So next year she's now withdrawing $252,000 out of that IRA, remember the year before she was taking only $113,000. So $252,000 now out of the IRA. And so you go all the way down to the here to the bottom and you'll see taxes only went up by a little bit, about $10,000 or so.
(03:03):
There is now $34,000 in federal taxes. And so why is that? Well, it's very simple. It's just because she was able to itemize and her itemized deduction is now about $110,000. Let's take a peek at the Schedule A. You'll see right here, the way that that works, she's 67 years old, remember? So what she can do is we take a look at her total AGI for the year $283,000, multiply that by 7.5%. That equals this number, this $21,000 number and anything above that amount can be itemized. So that's this number right here. $131,000 minus $21,000 equals this $110,000 figure. And again, I kept it simple. No other state taxes or anything else like that. So take that $110,000, apply that back here on the front page here of the 1040, and that's what makes that difference so that now she's only paying $34,000 in taxes. Remember again, the year before it was $23,000. So she's withdrawing a lot more money, but only paying a little bit more in taxes. Alright? So it's important to understand how these things work. Hopefully this has been helpful for you. If you had any questions on this, hopefully this cleared up any of those questions, make sure you like the video, make sure you subscribe. I'll see you soon.