It seems that we’ve all had the supposed benefits of traditional retirement accounts pounded into our heads. And while they do have some benefits, they also have some downsides that no one ever talks about. Let’s take a look at the potential liability these accounts face.
Many states have laws that protect retirement accounts from lawsuits. Some states allow retirement accounts to been fully exempt from judgements. Others allow you to exempt only part of your retirement account. However, even if your state’s laws exempt the entire account from creditors, you’re not completely out of the woods.
Long-term Care
Long-term care is expensive. Many folks either 1) plan for using benefits ahead of time to pay for long-term care; or 2) end up using benefits after they’ve spent down all their money on long-term care. Obviously, planning ahead to qualify for benefits such as Medicaid to pay the cost of long-term care can help to preserve hard-earned money and property.
The thing about Medicaid or any other long-term care benefit such as VA Pension Benefits, is that they are “means based,” meaning that you can only have a certain amount of assets if you want to qualify. This tends to turn many people off and keep them from applying for a potentially helpful benefit because they assume they must be indigent to qualify.
That’s not entirely true. There are many assets you can keep e.g. a home, a car, life insurance, prepaid funeral etc., and still qualify. What most people don’t know, however, is that your retirement account is an asset that counts against you for long-term care benefit qualification. Thus, if you have a substantial amount of assets in your retirement account, you may be disqualified from having your long-term care paid for.
Estate Tax
Not everyone is subject to the estate tax. In fact, your gross estate must reach a certain value at the time of death before it can be subject to federal estate tax–this is called the “estate tax threshold.” For the last few years, the estate tax hasn’t been a factor for most. However, the threshold is subject to being lowered and will be lowered in the very near future. This means that more and more folks could be subject to significant taxation of their estate before those assets pass to their loved ones.
I mentioned “gross estate” above. This refers to how the amount of assets one has at death are calculated to determine whether they are over the threshold. If your “gross estate” is over a certain amount (the threshold), you get taxed.
That begs the question of what assets are included in the gross estate calculation. Despite some misunderstanding to the contrary, your retirement account will be included in that amount. Therefore, if you have substantial assets in a retirement account at the time of your death, it could \subject your entire estate to taxation.
What makes Traditional Retirement Accounts Potentially Dangerous?
Let’s say you either need long-term care or you are trying to avoid the estate tax. In either instance, let’s say that you have substantial assets in a traditional retirement account. Based on your goal, you want to lower the number in that account. So, what’s the solution? You should move the money out of there, right?
Well, here’s the kicker. If you move the money, that means you must take it out of the traditional retirement account. And that means you must pay the tax on the money. Sounds scary right?
Here’s the thing, somebody at some point will have to pay the tax on that money anyway (maybe your child at a higher rate). If you move the money to something that can protect it, like a trust, then you pay the tax and get it over with. You also have the potential of qualifying for much needed long-term care benefits. However, if you wait, you could end up using the money in the retirement account to pay for long-term care while paying the tax everytime you make a payment to the facility. Furthermore, waiting could result in a hefty estate tax.
Traditional retirement accounts may not be the holy relics that they have been advertised to be. While they have their benefits, they are not without their flaws. If you have questions about retirement accounts and how to protect them, give the experienced attorneys at McIntyre Elder Law a call today 704-259-7040.
Estate Planning & Elder Law Attorney
