High Medical Expenses : Single Person Age 62 with $1 Million of Financial Assets

This case demonstrates the additional longevity that is possible by carefully managing the location and timing of asset withdrawal to deal unforeseen medical expenses.

By judiciously withdrawing funds tax efficiently, she was able to deal
with her end of life medical expenses
Financial Facts:
$750,000 in 401(k)s
$250,000 in regular taxable accounts

Celia Age 62 with $1,000,000 of assets

She plans to spend $56,600 after taxes in the first year and an inflation-adjusted equivalent amount each year thereafter. She spends that amount until his health deteriorates at age 84. He spends the next two years in an assisted living facility before passing away. His after-tax spending the last two years is at an annual level of $80,000 in today’s dollars, which translates into a daily rate in the assisted living facility of $200 per day plus a little extra for incidentals. She begins Social Security at 62.

Celia is a fictional representation of an actual retiree. The numbers involved in this case study are real.

Options Compared

Option 1: She withdraws the funds tax inefficiently from her financial portfolio.

Option 2: She withdraws funds tax efficiently from her financial portfolio. Each year, she withdraws funds from his 401(k) and taxable accounts in a fashion that is designed to increase the longevity of her portfolio.

We assume she maintains a 50% stocks-50% bonds after-tax asset allocation with stocks earning 7% per year and bonds earning 3%, both historically conservative assumptions. Other assumptions are provided below.

In Strategy 1, her portfolio runs out of money in 2033, her last year of life; it provides most of her needs that year but runs out of money near the end of the year.

In Strategy 2, her portfolio provides all her financial needs during her life and it has about $292,000 remaining primarily in her 401(k) at her death at the beginning of 20341. The tax-efficient withdrawal strategy allowed her portfolio to provide all her financial needs with substantial funds remaining for her beneficiaries.

One reason for the success of Strategy 2, the tax-efficient withdrawal strategy, is that it saved sufficient pretax funds in the 401(k) to offset the tax-deductible medical expenses in her last two years.

1. The Figure on the next page shows an after-tax financial portfolio value of about $248,000 at his death at the beginning of 2034. Since the portfolio contains almost only pretax funds in his 401(k), this translates into a 401(k) balance of about $292,000 of pretax funds that would be available to his beneficiaries. Unlike other advisors, our model recognizes that taxes exist. Thus each pretax dollar in a 401(k) is smaller than each after-tax dollar in say a Roth IRA. Our model also recognizes the differences in taxation amount funds in 401(k), Roth IRA, taxable account, non-qualified annuity, and other savings vehicles.

Assumptions: She maintains a 50% stocks-50% bonds after-tax asset allocation with stocks earning 7% per year including 2% dividend yield and bonds earning 3% interest per year. For the stocks, 20% of capital gains are realized each year with all gains being long term. The original cost basis of assets held in the taxable account is set at the market value. His Primary Insurance Amount for Social Security is $1,500 a month and his Full Retirement Age is 66. Since she begins Social Security benefits at age 62 she will receive $1,125 per month in today’s dollars. Both strategies allocate stocks to the taxable account and bonds to the 401(k) to the degree possible while maintaining the 50% stocks-50% bonds after-tax asset allocation. We assume she takes the standard deduction each year until she itemized in the last two years. Furthermore, we assume inflation of 3% per year with all tax brackets, standard deduction, over 65 tax exemption, and personal exemption amount rising with inflation.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal advisor regarding such matters