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How Retirement Savings Can Protect Against Extraordinary Long-Term Care Expenses

posted by AHIP

on September 12, 2018

Allowing Americans to use a portion of their retirement savings to pay for long-term care insurance premiums provides them with greater affordability, choice, financial security and peace of mind.

More than half of all Americans turning age 65 today will need long-term care (LTC) at some point in their lives.* The security and financial stability provided by LTC insurance can help our seniors age with confidence. Unfortunately, arcane retirement plan rules make it almost impossible for an individual to use their retirement plan savings to purchase QLTCI. Tapping into the $13 trillion of existing retirement savings for the purchase of QLTCI may be the only way many seniors will have any chance to protect themselves from the financial devastation that can result from extraordinary LTC costs.

This also creates a burden for loved ones. When a person needs LTC, their spouse often becomes the most important caregiver—and has to find a way to pay the LTC costs. American families deserve better peace of mind as they age.

The societal burden of LTC costs will increase dramatically. The Congressional Budget Office estimates that spending by the federal government, states, and individuals on LTC for those aged 65 and older will increase from 1.3 percent of Gross Domestic Product (GDP) in 2010 to 3 percent of GDP in 2050. No single solution will be able to address these impending unmet financial needs, but offering Americans more flexibility in how they use their retirement savings is an important part of any solution.

Leveraging Retirement Savings Through the “Within Plan” Approach

Public policy for qualified retirement plans strongly encourages Americans to plan for a financially secure retirement. The strong possibility of high LTC costs is a serious retirement risk. Planning for the possibility of LTC costs should be part of a comprehensive retirement strategy. By removing the barriers that prevent retirement plans from investing directly in QLTCI (the “within plan approach”), individuals will be able to allocate a portion of their retirement plan assets towards the purchase of QLTCI, which would be treated like any other investment of the retirement plan.

Under such an approach, individuals would be permitted to make premium payments for “within plan QLTCI” policies from their 401(k)s, 403(b)s, IRAs, and other retirement plans.

Not only does this provide an individual with a greater sense of security, it allows them to protect their loved ones from complete erosion of their retirement savings, decreasing the burden on the caregiver spouse.

Proposed Tax Treatment of “Within Plan QLTCI”

We support policy changes that would allow retirement plans to invest directly in LTC coverage. This improvement will allow Americans to treat their LTC coverage like any other retirement plan investment. Critically, for the millions of baby boomers in or approaching retirement, the impact on tax revenue would be minimal, because they would be using existing retirement plan savings to protect themselves from potentially catastrophic LTC costs.**

Because the within-plan LTCI would be treated as a retirement plan investment, premium payments would not be taxable distributions. Instead, they would be treated as a movement of one plan investment to another plan investment. And if the policyholder becomes chronically ill and entitled to QLTCI policy benefits, those benefits would be paid to the retirement plan.

This means those benefits would be treated in the same manner as income on any other plan investment: included in the recipient’s taxable income when distributed under the general tax rules governing retirement plan distributions. The benefits would be taxable if the participant has a traditional, deductible account; they would be tax-free if the participant has a Roth-type account. Similarly, the costs of LTC would be deductible under the general tax rules for medical costs.

Implementing the within-plan QLTCI approach would require changes in a variety of tax rules, including removal of prohibitions on the purchase of QLTCI in retirement plans; changes in the age 70½ minimum required distribution rules; specific requirements on the percentage of retirement assets that could be invested in within-plan QLTCI; and clarification of the interaction with the medical deduction rules.

However, even as within-plan QLTCI offers a cost-effective opportunity for seniors, this approach would have only a modest tax revenue loss. That’s because preexisting retirement savings used to pay premiums are already in a taxfavored format. It is a small investment to ensure coverage and care for America’s seniors—and a smart investment that reduces future state budget increases for Medicaid and other public programs.


* HHS, ASPE Issue Brief on Long-Term Services and Supports for Older Americans, February 2016.
** Conceptual Analysis of Potential Revenue Effects of Three Proposals to Encourage the Purchase of Long-Term Care Insurance; Mary M. Schmitt, Optimal Benefit Strategies, LLC; August 2018