Using IRAs to Fund Long-Term Care

Jackie Bedard
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Attorney, Author, and Founder of Carolina Family Estate Planning

Your parents and grandparents “retirement planning” probably consisted of managing their income for Social Security and pensions and creating a household budget and they probably had “rainy day” savings that was set aside for unexpected expenses.

401(k) plans and Individual Retirement Accounts (IRAs) were born in the mid to late 70s, but they didn’t really start gaining significant traction until the 1990s and 2000s.  Over the past two decades most private sector companies have done away with corporate pension programs in favor of 401(k) and similar retirement plans. This has led to a massive shift in the importance of retirement planning for retirees who now bear much more responsibility for managing their retirement funds.

Retirement plans like 401(k)s and IRAs can be a powerful retirement-saving tool, but they can pose challenges when it comes to long-term care planning, such as:

  • Retirement plans cannot be directly transferred to Medicaid Asset Protection Trust. Instead, you would have to liquidate the account, pay ordinary income taxes on the funds, and then transfer the assets to a Medicaid Asset Protection Trust.
  • If you purchase a traditional long-term care insurance policy and need to use retirement plan funds to pay the premiums, you’d have to make a withdrawal from your retirement plan, pay ordinary income taxes on the withdrawal, and then pay your insurance premiums.
  • A retirement plan such as 401(k) or IRA is not allowed to own life insurance, so you cannot directly use an IRA to purchase a life insurance policy with long-term care rider.

Of course one option is to use your income or non-retirement plan accounts to fund your long-term care planning, but what about options for funding your long-term care planning through your retirement account?

Potential Solution 1: Pay Some Taxes Annually

One option is to pursue either a traditional long-term care insurance policy or a life insurance policy with a long-term care rider that you pay for annually. If you don’t have non-retirement plan funds available to pay the insurance premiums, then each year, you’ll take a withdrawal from your retirement account to pay the insurance premiums, but you will pay ordinary income taxes on the withdrawal from the retirement account.  Now, I know most people hate paying taxes, but remember, you didn’t pay taxes on the funds when they want into the account and the whole point of having the retirement account is to pay for retirement-related expenses (such as long-term care or long-term care insurance).

Potential Solution 2: Life Insurance/Annuity/Long-Term Care Insurance Combination

This is really a variation of Solution 1. In an effort to streamline your policy, some companies offer a hybrid life insurance/annuity/long-term care option. A life insurance policy with long-term care rider can’t be purchased directly through your retirement account, but an annuity can be owned by your retirement account. Basically, the company sets up an annuity within your IRA that each year pays the premium on the life insurance with long-term care rider which is outside of your retirement account. Each year, you will receive a 1099 and have to report the income for the withdrawal from the retirement plan (i.e., the distribution from the annuity).

Retirement accounts are always individually owned, by law. However, some of these policies can even be structured to be a joint policy for a couple. For example, if most of the couple’s assets are in the husband’s retirement account, he can use those funds to purchase joint coverage for himself and his wife.

Let's take a look at an example:

Tim and Patty want to plan ahead for the possibility of long-term care needs during retirement. Patty’s parents needed long-term care and she saw how financially devastating it was. Tim does not like the “use it or lose it” nature of traditional long-term care insurance. Most of their savings is in Tim’s IRA. 

Tim & Patty Accounts

 

Tim and Patty decide to reposition part of Tim’s IRA into a combination annuity/life insurance with long-term care rider. The base policy creates a death benefit of $517,000 which Tim and Patty can also access at a rate of $10,000 per month each for long-term care needs. They decide to also purchase an additional rider that creates an unlimited long-term care benefit pool for an additional annual premium. Thus, if both Tim and Patty were to need long-term care at the same time, they could draw up to $20,000 per month from the policy ($10,000 each) for as long as they live.

If they never need long-term care, the death benefit will instead pass to their children whom they’ve named as beneficiaries on the policy. If they only need a small amount of long-term care, the amount used will reduce the death benefit. For example, if they use $100,000 for long-term care costs, then the remaining death benefit will be $417,000.

Tim & Patty-IRA for Long-Term Care

 

Rather than having to withdraw the $250,000 as a lump sum to fund the life insurance with long-term care rider, the policy has an internal 20-year annuity that pays the life insurance premium each year. Basically, rather than Tim having to make a withdrawal from his IRA each year, deposit the funds, and then write a check to the insurance company for the life insurance with long-term care rider, the insurance company handles all of this for Tim internally and just sends Tim a 1099 each year so he can report the "withdrawal" when funds were transferred from the annuity (which is inside the IRA) to the life insurance with long-term care rider (which is outside the IRA). 

Potential Solution 3: Annuity with Long-Term Care Rider

Annuities can be owned within a retirement plan, including an annuity with a long-term care rider.  The annuity with long-term care rider can be purchased using a trustee-to-trustee transfer—meaning that the funds are transferred directly from your retirement account to the insurance company. A trustee-to-trustee transfer does not constitute a withdrawal and is not subject to taxes at the time of transfer. 

We Can Help You Develop a Long-Term Care Plan

Having assisted many Wake County clients with long-term care planning, our team at Carolina Family Estate Planning understands that developing a long-term care plan is about not just protecting your own independence and dignity, but also protecting those you love from the physical, emotional, and financial toll that caring for a loved one can take.

We’ve helped many clients take an interdisciplinary approach to their long-term care planning by exploring both legal and financial options. Usually, a well-rounded long-term care plan will involve a combination of legal, health care, and financial tools to meet your goals and maximize your protection. To get started, register an upcoming seminar to learn more or call our office at 919-443-3035.

 

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