The Millennial's Retirement Pot of Gold
The millennial’s retirement Pot of Gold might be held in Roth investment accounts and/or a less popular account that can help mitigate their long-term care risk while maintaining flexibility and liquidity of the assets designed to address care. Let us take a look at that less popular account here.
Long-term care affects about half of us. It can be quite costly and is not normally an item many people take seriously in their retirement budget unless they have cared for someone personally or witnessed someone close to them provided care. The younger you are, typically, the less you think about it.
But not thinking about it doesn’t make the risk go away, and the cost of that risk is steadily rising. Long-term care insurance is currently in disarray and filled with uncertainty. Sales are plummeting and premiums on older policies are constantly being raised as poor pricing and low interest rates over the past two decades have been a toxic combination for insurance companies.
The alternative sold to those that can afford it is a hybrid product that combines life insurance with a long-term care rider. To be frank, that is a poor place to allocate excess cash flow. There is limited flexibility within the policy and little to no real liquidity options for decades without significantly hindering the benefits of the policy. In my opinion, the return on investment is also below what I expect of my hard-earned money despite what you may be told by insurance salespeople.
I got my start in the financial services business at a major mutual life insurance company, so I had a chance to study this part of insurance up close. I’ve thought about it quite a bit as a planner and feel now I see a different solution for those of us who are younger.
For millennials and really those under an age of around 45 there is an option out there that just makes a lot of sense to me: Health Savings Accounts (HSA).
The HSA allows you to defer money on a pre-tax basis into an account that can also be accessed tax-free for qualified medical expenses. This is a huge deal when you pay attention to the compounding effect of taxes on your earnings.
It does require you to have a high-deductible health plan and it is important to understand the obligations this could entail. (This is a discussion for a further post)
But if you pay for your medical expenses out of pocket now and invest the HSA contributions in equities, you can realize far greater returns as shown below:
- $7k/yr in pre-tax contributions per year for 30 years (current family maximum contribution)
- 6% annualized investment return
- ~$550k balance at age 65
- ~$1.09M if you start the same strategy at age 25 and invest for 40 years!
If you got more conservative around retirement age with your investments (very reasonable), didn’t need long-term care immediately upon retirement (likely), and only realized 4% returns with no more contributions over the next 20 years you would have ~$1.2M to use as you see fit. (~$2.3M if you started at age 25)
Let’s take a look at some of the positive benefits of this strategy.
What is TAX-FREE from this account?
- Medicare Premiums (something all 65+ Americans have now)
- Regular Medical Expenses (certain in some shape, form, or fashion in retirement)
- Long-Term Care Expenses (affects about 50% of us with the median paying about $110k total)
You also don’t have to qualify for long-term care insurance, which is much more difficult than many realize. Additionally, you are not locked into paying premiums for the rest of your life for care that you have a 50% chance of not needing. We enjoy helping you have flexibility with your money!
Why is this better than an insurance-based product?
- Flexibility of Premiums (Contributions) and Use
- Liquidity at all points
- Option to invest in Equities, which consistently provide higher returns over long-term
Another great advantage of this account over insurance options is that you can also access the account for a wide range of retirement expenses at any time, not just the specific benefits allowed under the terms of the insurance contract.
The only caveat to non-medical expenses is that you must recognize those distributions as ordinary income, but in this regard, it behaves similarly to the pre-tax portion of your 401(k). So, no real penalties or punishment here. Just the usual taxes. One way to get around this is saving your receipts for medical expenses you incurred throughout your life. Distributions from an HSA are based on medical expenses incurred while the account is open which does not have an expiration date. Thus, the copays and out of pocket costs you incur now can allow you to access those HSA funds tax free later.
This all sounds great, right? Every coin has two sides.
The downside to this strategy is that it requires a great deal of delayed gratification and that can be difficult for some to stomach. There are many people in their 20’s, 30’s, and early 40’s who have their budgets fairly well established and may not have the ability or desire to suddenly stock away almost $600 per month pre-tax while footing a larger portion of your medical bills.
But that doesn’t mean that you can’t start with a small commitment and build on it annually.
One of the few advantages an insurance-based product has over this strategy is if you were subject to an extreme outlier event like early onset Alzheimer’s in your 50’s. While this does happen, it is important to understand the low probability of this happening and to not make emotional decisions based strictly on outlier events. This is one of the top sales tactics utilized by commission-based insurance salespeople.
Like with most financial planning techniques, this subject is more complex than what can be covered in a short blog post. The reasoning behind a short blog post on a complex subject is to get the idea in your head so that you can read more about it or call a trusted fiduciary advisor to walk you through the pros, cons, and finer details of implementing a strategy like this.
This habit can be a great tool for combatting the potentially high costs of long-term care while not giving away all your flexibility and investment returns to an insurance company. More questions about HSA? Let’s talk about it.