Does it make sense for you to opt out of coverage?
James B. Twining, CFP
Much to the chagrin of our Washington state government, the citizenry of the state will not approve a corporate or personal income tax. But never fear, the government makes up for it with a myriad of smaller tax bites of every description. Think of it as being nibbled to death by ducks.
The most recent addition to the list is the Long-Term Services and Supports Trust Act. Beginning in January 2022, a .58% payroll tax will be charged to employees with W2 income, which includes hourly wages, salary, bonuses and certain stock plans. Employees have a binary choice: pay the tax or buy a personal long-term care policy to avoid it.
The goal of this article is to provide perspective on each choice.
Opinion: Long-term care insurance is rarely the most effective solution
The reason for the existence of insurance is the distribution of risk. Insurance can be an effective solution to the extent that the protected event has two characteristics:
The event is catastrophic, and the event is rare.
The premature death of a 30-year-old breadwinner is an event that meets both criteria: It can be catastrophic to a surviving spouse and children (as it results in a complete loss of future income) and it is quite rare, affecting only about 1 in 700 households each year. As a result, the risk of catastrophic loss can be vastly reduced by insurance, replaced by a cost-effective, term life premium.
If an event is not catastrophic, it is typically wiser to simply live with the risk and pay for the loss if and when the event occurs. There are many such events that do not cause catastrophic loss, from dental bills to the breakdown of an appliance or body damage on a car. Over time, the person who has insurance coverage for these events is likely to pay more than those who choose to self-insure. Those who choose insurance coverage are effectively paying for the less-than-catastrophic events through the conduit of the insurer while also paying the administrative costs and profits of the insurance company.
If an event is not rare, there are not enough insured people over whom to adequately spread the risk. Long-term care scenarios are not rare. The rough estimate is that the risk is spread among only two or three insured people, resulting in high premiums. The frequent claims add to administrative costs, which cause yet higher premiums and lower benefits. If there is another solution, it is certainly worth exploring.
Fortunately, for successful investors, there is. Consider that when a single person moves to a nursing home or a couple moves to a continuing care community, their residence can be sold. The equity in the residence often exceeds the benefit paid by modern long-term care policies. In addition, a successful investor has financial assets that often will be sufficient to pay the long-term care costs.
Those who might be better candidates for long-term care insurance are those without sufficient assets to self-insure. Unfortunately, they are the very people who are most negatively impacted by large premiums. High long-term care premiums can increase the withdrawal rate on a retirement portfolio, contributing to an eventual complete depletion of capital, even if a long-term care scenario never occurs.For these reasons, long-term care insurance is rarely the most effective solution to the risk of a long-term care scenario. Unless the investor is extremely risk-averse, it is best avoided in favor of other solutions.
Insight: Washington state’s plan is damaging for high-wage earners
The maximum benefit through the Washington plan is $36,500. To qualify for the benefit, a wage earner must pay for at least 10 years, or three of the past six years. The total tax paid by six-plus-digit wage earners over various time periods is listed in the table below. The wages are assumed to grow at an inflation rate of 3% per year.
This is every bit as bad as it looks. Even without the probable real tax increases, the wage earner making $250,000 will pay $52,866 over 25 years for the unlikely possibility of a $36,500 benefit. The $1 million wage earner over a 25-year career will pay $211,464 in tax for a maximum benefit of $36,500!
It gets worse: On the margin, people who do not have health problems will be more likely to obtain private coverage, exempting themselves from the plan. This leaves a disproportionate number of people who have difficulty obtaining long-term care coverage on the plan. This “selection risk” almost certainly will cause large real increases in the tax, which are not included above.
Consideration: Cost comparisons for one scenario
The rule does not specify a minimum amount of long-term care benefit necessary to opt out. Therefore, my advice would be to obtain the minimum benefit that an insurer will write, which is currently $3,000 per month, over a two-year period — for a total of $72,000, or roughly double the state plan benefit.Here is one scenario I ran on an example client: male, age 60, standard health rating, earning $500,000 in W2 income annually with 3% raises, retiring in 10 years. I am assuming that a long-term care benefit is neither needed nor desired, leaving only one goal: cost reduction.
Personal long-term care coverage: A 60-year-old male with a standard health rating can obtain a traditional long-term care policy paying $3,000 per month over a two-year benefit period for a premium of $1,192 per year, or $11,920 in total premiums over 10 years, at which time the policy would be cancelled. If we discount each annual premium at a 3% inflation rate, the present value cost is $10,473.
The Washington state plan: A 60-year-old male earning $500,000 per year with 3% raises will pay a total tax over 10 years of $33,241. When discounted at a 3% inflation rate, the present value cost is $28,150.
In summary, under our assumptions, the tax for the state plan is almost triple the cost of personal policy premiums. This employee should apply for a personal long-term care policy, thus opting out of the state plan.
However, do not assume that it is always better to opt out. For those with lower wages and less time until retirement, it might make more sense simply to pay the tax. I recommend asking your financial adviser to put a pencil to this and determine the wise choice for you.
Washington state long-term care issuers and their agents are swamped because of this new tax, and there also can be health hurdles to overcome in order to qualify for coverage. To opt out, personal coverage needs to be in place by Nov. 1, so if you decide to buy personal coverage, do not delay!
James (Jamie) Twining is the CEO and founder of Financial Plan, Inc., and a CERTIFIED FINANCIAL PLANNER (TM) Practitioner who works with an exclusive high net worth client base. Jamie has a niche advising BP Cherry Point refinery employees. A devoted husband, father, and grandfather, Jamie enjoys spending time with his family and any water sport that begins with “s”: swimming, surfing, sailing, scuba diving, snorkeling, stand-up paddle boarding, and salmon fishing.