HOW TO FINANCE PRIVATE PAY
IS THERE A “PECKING ORDER” FOR LIQUIDATING MOM’S AND DAD’S ASSETS?
Absent the availability of long term care insurance or public benefits, families are forced to liquidate mom’s and dad’s assets in order to ”private pay” for monthly long term care costs.
Is there a rational order as to what assets should be liquidated first over other assets?
Every family’s facts and circumstances are unique to themselves; however, there are some general rules to consider following. Remember, the overall guidance is to preserve and stretch out mom or dad’s assets as long as possible, since many times you really cannot project for how long these assets may be needed. Uninformed decisions may not include considering income tax implications, maturity dates, early surrender charges, and the like. Asset values may be drained prematurely as a result.
Take an inventory of all “soft” and “hard” assets mom and dad may own. ”Soft” assets are usually assets that are easily liquidated. These items would include bank savings accounts, certificates of deposits, stocks, bonds, mutual funds, annuities, life insurance policies (those with cash surrender value). Then divide this inventory into “tax deferred” and “non-tax deferred” assets.
“Tax deferred assets” usually include many of the “soft” assets previously described; however, these assets are normally contained within an IRA, annuity, or a 401(k) plan. The originating investment cost probably was tax deductible at the time and any subsequent appreciation went untaxed. “Non-tax deferred assets” have already been taxed and most likely any income generated off the asset has also been taxed.
”Hard” assets include the personal residence, vacation home , rental property, etc. These assets are usually not as easily liquidated and take longer to convert to cash.
As part of this first step, take an inventory. This means obtaining account balances and fair market values when it comes to stocks and bonds as well as real estate and determine how each asset is titled, (ie. who owns it). Sometimes parents name children as partial owners, and do not tell them. Ownership is important, particularly when it comes time to selling. Children selling parents assets, partially owned by a child, may create undue income tax surprises.
Once this inventory is taken, the general rule when liquidating assets is to select the “non-tax deferred assets” first since they most likely carry the least amount of immediate tax burden. Caution is advised as to understanding maturity dates of these assets. Even tough they are liquid, interrupting a maturity date may cause early withdrawal penalties or surrender charges. Individual stocks and bonds with built in losses, held within a taxable account, may also be high on the list to liquidate sooner than later, since capital losses can offset up to $3000 of other income sources on the parent’s tax return, or can even offset capital gains dollar for dollar.
Liquidating “tax deferred assets” should be delayed as long as possible, since an income tax burden is likely to follow. Cash withdrawn from a Traditional IRA is always taxable. If mom or dad created a ROTH IRA (sometime since 1997) in addition to Traditional IRA’s, preference should be given to liquidating the ROTH IRA first. ROTH IRA’s are generally tax free if certain rules are complied with.
Liquidating annuities generally will create taxable income; however, depending when the annuity was purchased, part of a redemption may be cost recovery and only partially taxable. Check with your annuity salesperson first. Also, most annuities impose a sliding scale of surrender charges for the first 5-7 years of annuity. Determine were the particular annuity is in its own life cycle. Keep in mind that most annuities allow for a 10 % annual liquidation amount without penalty, no matter where the annuity is in its life cycle.
“Hard assets” usually are sold later since a parent may still be residing in their house, or there may be significant “built in” taxable gains, such as with lake property. When selling your parent’s house, look carefully as to who owns the house. If the deed is held as a “life estate”, one or more children may be named as remaindermen, which could create an income tax liability for them if the house is sold during the parent’s lifetime.
Sometimes, families just do not have many choices available, and so liquidating real property is done by necessity. So as to reduce any potential tax burden, look for building improvement receipts as well as the original purchase papers. When selling a taxable piece of real estate, one is allowed to offset the original purchase/building cost plus lifetime permanent improvements against the sales price.
Keep in mind that part of your monthly long term costs may be tax deductible.
The rules vary depending if a loved one is cared for within a skilled nursing facility, an assisted care retirement community, or a senior independent retirement community. Work with your campus administrator as to which portion of your monthly fees can be allocated to medical vs. rent expense. Having this useful information may offset part of any taxable gains you may have created by liquidating taxable assets.
James L. Hintzke is a Certified Public Accountant and Certified Senior Adviser, specializing in Elder Care Planning for seniors and their adult children with over 25 years experience, located on National Avenue in New Berlin, Wisconsin. He can be reached at
(262)797-8442 or email email@example.com.
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