One of the challenges of retirement is, if I need it, how will I pay for the premiums and Long Term Care (LTC) costs? Many people mistakenly believe that Medicare will pay for the cost. While it will pay for rehabilitation care, it does not pay for classically defined long-term care. That being said, how can you start paying or thinking about paying for LTC?
Many people might assume that they would just take money out of their 401(k) or IRA account and pay that way. Well, of course, that will mean you’ll have to pay additional taxes. However, one of the big issues with any type of insurance is insurability. The older we get, the more often we have various illnesses that may make us uninsured by insurance carriers for LTC.
The SECURE 2.0 Act Opportunity
Being able to be insured (insurability) should always be a concern. Waiting until later to buy may mean your health conditions have changed and this may increase your premiums or leave you completely uninsured. To increase your chance of being insurable for long-term care is to start paying before you retire. The Setting Every Community Up for Retirement Enhancement 2.0 Act, also known as the SECURE 2.0 Act, gives you the opportunity to pay for LTC premiums by taking distributions from your 401(k), 403(b), 457, TSP and IRA accounts . This idea seems to be best suited for those between 50 and 60 years old. This allows you to avoid the 10% penalty for making withdrawals before age 59 1/2. You still have to pay taxes on pre-tax withdrawals.
When you turn 50+, you can make catch-up contributions to your 401(k) and IRA accounts. In 2023, the cap contribution is $7500. Imagine being able to withdraw $2,500, avoid the 10% penalty, and only pay taxes on the withdrawal. If you’re in the 24% marginal federal tax rate, your withdrawal excluding state taxes will be about $2,000. You could then use that $2,000 to pay for your LTC premium. I recently received an offer for a couple who are in their 50s. The premium given by one of the carriers was about $2,000 per person. But it gets even better.
IRS deduction of long-term care insurance premiums
Did you know there was a reservation available for LTC premiums? Up to certain limits, the IRS allows deductions of LTC premiums. In tax year 2023, if you are between 41 and 50 years old, the limit is $850, 51 to 60 $1690, 61 to 70 $4,510, and 71 + $5,640. This medical expense deduction has a limit of 7.5% of adjusted gross income. This is a per-person limit, not an individual, so a couple between the ages of 51 and 60 could deduct $3,380. This increases significantly when a partner reaches 61 and now the amount increases to $4,510. From a tax planning point of view, it would be great to know that expenses today, which may be considered high, will get some tax relief for your treatment in the years to come.
Why does the government offer this? Medicaid is the number one provider of LTC in America. Unfortunately, Medicaid means that your assets will be liquidated to pay for your LTC. I have personally seen this happen to family members.
Fighting the feeling of not wanting long-term care
For many of us the challenge with LTC is that we simply don’t want to ever need it. We don’t want it. And we certainly don’t want to pay (although the longer we wait, the higher the premiums will be). However, with costs skyrocketing, most people will not have enough assets to be able to cover the costs. If you add considerations of transferring assets to heirs, this can be dismissed with an LTC event. If you have a spouse, this can make things even worse financially.
Paying for LTC sooner rather than later can help lock in insurability today, which is not guaranteed in the future. When planning for LTC, like most things financially, the path is likely not straightforward. One needs to consider how much money is needed to continue to fund there, 401(k), 403(b), 457, TSP and other assets. Another aspect to all of this is whether you have a Health Savings Account (HSA).
HSAs, if you invest them, benefit from not touching your money for a while. This option is triple tax-free (no income tax, no capital gains taxes on growth, and no taxes when used for health-related expenses), and you can also pay for LTC premiums outside of the HSA. I think it’s worth considering holding off on using your HSA until you retire so it can benefit from a longer period of tax-free growth, rather than using it to pay for current expenses. You could also use it to pay for Medicare premiums and other health-related expenses.
Secure Act 2.0 provides a unique programming opportunity. I think it’s worth going through some rigorous analysis to assess whether withdrawing your 401(k), 403(b), IRA, etc. retirement savings. it now makes sense to you.