Using IRAs to Fund Long-Term Care Insurance

Looking ahead to retirement raises questions about health care and living arrangements. As long-term care costs drastically rise, American families wonder how to protect their retirement funds. Ahead, we explore how to use IRAs and retirement accounts to fund long-term care insurance.

Rising long-term care costs

Long-term care, like nursing home stays or in-home caregivers, can cost over $100,000 annually. These rising expenses can quickly drain your savings, creating financial stress during retirement.

Investing in long-term care insurance now is one option to fund long-term care later. Long-term care insurance helps cover the costs of assistance with daily activities, like bathing or dressing, or care in a nursing home or assisted living facility.

How IRAs can help

Individual Retirement Accounts (IRAs) have tax advantages that can help your money grow faster. Funds in IRAs are considered "qualified money," meaning they meet the requirements of the Internal Revenue Code for tax advantages.

There are two main types of IRAs, each with distinct benefits:

1. Traditional IRAs: With a traditional IRA, you contribute pre-tax dollars, which reduces your taxable income now. The money in your account grows tax-deferred, meaning you don't pay taxes on earnings until you withdraw them in retirement. This is especially helpful during your working years when you might be in a higher tax bracket. When you retire and begin taking distributions, the withdrawals are taxed as ordinary income, which may be at a lower rate.
2. Roth IRAs: Roth IRAs are funded with after-tax dollars, so you don't get an immediate tax break. However, the money grows tax-free, and qualified withdrawals in retirement are not taxed. This gives you more flexibility and control over your savings since you won't owe taxes on the money you take out for long-term care or other retirement expenses.

Tax advantages of IRAs

The tax benefits of IRAs can make a big difference in how much money you'll have in retirement.

Here's how they help:

• Tax-deferred growth: In both traditional and Roth IRAs, your investments grow without being taxed each year, which lets your savings compound more effectively.
• Tax-free withdrawals (Roth): Qualified withdrawals from a Roth IRA in retirement are completely tax-free, which can be a significant advantage if you expect to be in a higher tax bracket.
• Contribution flexibility: Depending on your income and tax situation, you can choose the type of IRA that works best for you.

IRAs not only build your retirement savings but also provide a safety net for future expenses like long-term care. By taking advantage of the tax benefits, you can grow your savings while preparing for health care costs that might arise later in life.

Using IRAs for long-term care insurance

IRAs can cover long-term care insurance premiums, but there are specific rules and strategies to consider.

Mechanisms for using IRAs for long-term care insurance

Direct payments

Some insurance companies allow premiums to be paid directly from your IRA to simplify the process. However, this method may still count as a taxable distribution unless it qualifies for an exception.

Qualified distributions

In certain cases, you can make penalty-free withdrawals from your IRA for medical expenses, including long-term care insurance premiums. The Pension Protection Act of 2006 allows tax-free withdrawals from certain retirement accounts if used for hybrid policies (e.g., life insurance with long-term care benefits).

1035 exchange

If you have an annuity or life insurance policy with a cash value, you may be able to use a 1035 exchange to transfer those funds into a long-term care insurance policy without triggering taxes. This option doesn't involve your IRA directly, but it's another way to fund long-term care needs tax-efficiently.

Tax implications and potential penalties

Taxable distributions

For traditional IRAs, any money withdrawn for long-term care insurance premiums is generally considered taxable income, which could push you into a higher tax bracket. Roth IRAs avoid this issue for qualified withdrawals.

Early withdrawal penalties

If you're under age 59½, withdrawing funds from your IRA may result in a 10% early withdrawal penalty on top of regular income taxes. Exceptions apply for medical expenses exceeding 7.5% of your adjusted gross income (AGI).

Medical expense deductions

Premiums for long-term care insurance may qualify as a deductible medical expense if your total medical costs exceed 7.5% of your AGI.

Advantages and disadvantages

Advantages‍

• ‍Tax deductions: Long-term care insurance premiums may qualify as a medical expense deduction if they exceed 7.5% of your adjusted gross income (AGI).‍
• Tax-free growth: Roth IRAs provide tax-free withdrawals in retirement, while traditional IRAs grow tax-deferred, allowing your savings to accumulate more effectively.‍
• Direct access to funds: IRAs provide a convenient source of funding for long-term care insurance premiums, especially if other savings are limited.‍
• Flexibility with hybrid policies: Hybrid policies combining life insurance or annuities with long-term care benefits can be funded with qualified money under the Pension Protection Act.

Disadvantages

• Depleting retirement savings: Using IRA funds for premiums reduces the amount available for other retirement expenses.
• Taxable income from withdrawals: For traditional IRAs, withdrawals are taxed as ordinary income, which could push you into a higher tax bracket.
• Early withdrawal penalties: If you withdraw funds before age 59½, you may face a 10% penalty in addition to taxes, unless the withdrawal qualifies for a medical expense exception.
• Complex rules and limitations: Not all insurance policies or hybrid products qualify for tax advantages. Rules around 1035 exchanges, qualified distributions, and deductions can also be challenging.
• Opportunity cost: Funds withdrawn from IRAs lose the potential for future growth.

Alternatives to long-term care insurance

While long-term care insurance can help cover the high costs of care, it's not the only option. For those who don't qualify for or can't afford traditional insurance, there are other strategies:

Medicaid waivers with a caregiver pay option

Some states offer Medicaid waivers that allow beneficiaries to receive care at home rather than in a nursing facility.

One program under some Medicaid waivers is Structured Family Caregiving, which allows family members to get paid for caring for a loved one.

Check your eligibility >>

Health Savings Accounts (HSAs)

If you have a high-deductible health plan, you can contribute to an HSA that offers these advantages: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses—including long-term care—are tax-free.

Hybrid insurance policies

Instead of traditional long-term care insurance, hybrid policies combine life insurance or annuities with long-term care benefits. These policies often allow unused funds to be passed to beneficiaries if the long-term care benefit isn't fully utilized.

Veterans benefits

If you or your spouse is a veteran, you may qualify for benefits through the Department of Veterans Affairs (VA). Programs like VA Aid and Attendance can help cover the costs of in-home care, assisted living, or nursing home care.

A note from Givers

The best option for care depends on your financial situation, health status, and family support system. Programs like Structured Family Caregiving can be a lifeline for families, while options like HSAs or hybrid policies offer flexibility and tax benefits. Planning is essential to protect your savings and secure your future.