Asset Allocation and Asset Location for LTC-Dedicated Dollars — Oblivious Investor

A reader writes in, asking:

“We have decided against long term care insurance and have allocated a portion of our portfolio for long term care expenses.

First question, what are your thoughts on the best asset location for these funds – Roth or Traditional IRA? Currently, we have allocated half in Roth and half in Traditional.

Second question, thoughts on where to invest this money, do you put in all into Vanguard Total Stock Market and let it ride, or do you do a more conservative approach?”

I don’t think there’s a clear-cut answer to either of those questions. The primary issue here is that, in order to implement a typical asset-dedication strategy, you have to know (at least roughly) when the dollars are going to be spent. With long-term care, we don’t know that information. We don’t even know if that cost will arise.

With regard to asset location, the theoretical goal would be to try to incorporate it into the broader retirement distribution plan (i.e., which dollars to spend each year), with the idea always being to spend tax-deferred dollars when your marginal tax rate is lowest. That is, we would create a year-by-year plan. For each year, we first ask how many dollars need to be spent in the year in question. Then we determine which dollars to spend to get to that level. First we spend from current income and taxable-account dollars where cost basis is at least equal to the current value. Then we spend from tax-deferred dollars, to use up relatively-low-tax-rate space (if any). Then Roth or possibly taxable.

But the practical reality is that meaningfully incorporating long-term care costs into such a plan is pretty much impossible, because, again, we don’t know when these dollars will be spent.

Similarly, for investment selection/asset allocation, in theory it would depend on your risk tolerance for these specific dollars. How much can you afford for them to decline — and by how much? The younger you are (i.e., the further away a long-term care need is likely to be), the greater the risk you can afford to take with these dollars — and the more return you might need in order to try to keep up with rising LTC costs.

At least in this case, depending on your age, you might be able to make some useful decisions. For example, if you’re age 50, you could say, “it will probably be at least 15 years, likely even longer.” And that’s enough to tell us something about the appropriate asset allocation. But if you’re in your 60s or beyond, it could be a few years from now, 20 years from now, or never.

Given those practical challenges resulting from the high level of uncertainty, I’m not sure how much is to be gained from making asset allocation or asset location decisions specifically for these dollars. If it were me, I think my personal approach would be:

1. Consider them part of the overall portfolio and continue making overall-portfolio level decisions for asset allocation and asset location.
2. If the desire is still to have dollars set aside specifically, do that via the “how much to spend” each year decision. For example if, in a given year, the plan calls for you to spend X% of the portfolio balance, instead spend X% * (portfolio minus LTC-dedicated amount).
3. If/when the LTC need does arise, make the decision at that time as far as which specific dollars to spend (i.e., stocks/bonds and Roth/tax-deferred/taxable).

With regard to that last step though, there is admittedly a potential problem in that, depending on the reason why you need care, you may not be in a position to actually make such decisions. If you’re married, making sure your spouse understands the household finances and the plans is important. Giving a trusted loved one (or trusted professional fiduciary) authority to act for you via a durable power of attorney can help. And keeping the portfolio as simple as possible is helpful to make it easier for another person to implement your plans.