Long-term care is one of the most significant expenses many retirees face. Annual costs can easily exceed $100,000 for nursing home care, with tens of thousands more for in-home or assisted living services. And for those without dedicated insurance or the savings to cover care, tapping a 401(k) may seem like the most accessible option.
Consult a financial advisor for help developing a financial plan for long-term care in the future.
Can You Use Your 401(k) to Pay for Long-Term Care Premiums?
The short answer is yes, you can use 401(k) funds to pay for insurance premiums. However, the process and tax implications require careful consideration.
The IRS allows you to withdraw funds from a traditional 401(k) at any time after age 59 ½ without penalty. These withdrawals can be used for any purpose, including long-term care premiums. 1
However, the distributions are treated as ordinary income, using marginal tax rates. This means a $10,000 withdrawal to cover premiums could result in a meaningful tax bill, especially if it pushes you into a higher tax bracket.
If you’re under 59 ½, withdrawing from your 401(k) to pay long-term care premiums typically triggers a 10% early withdrawal penalty. This is in addition to regular income taxes. 2
There are some exceptions, such as separation from service after age 55 or a hardship withdrawal. However, long-term care premiums alone generally don’t qualify for penalty relief.
For younger savers, this makes 401(k) withdrawals an expensive way to fund coverage.
How to Use Your 401(k) Directly
If you have decided on tapping your 401(k), it’s important to know how to access those funds so you can avoid unnecessary fees and headaches as best as possible.
There are several ways to draw from your account, but each comes with its own rules and tax implications:
- Standard withdrawals after age 59 ½. The simplest way to use your 401(k) for long-term care expenses is to take a standard withdrawal after age 59 ½, when the 10% early withdrawal penalty no longer applies.
- Systematic distributions. For ongoing long-term care expenses, setting up systematic distributions can create a predictable income stream from your 401(k).
- IRA rollovers. Rolling over your 401(k) into an IRA can expand your withdrawal options and investment choices. This may be useful when funding long-term care.
- The Rule of 55. If you leave your job in or after the year you turn 55, the rule of 55 allows you to take penalty-free withdrawals from that employer’s 401(k). However, income taxes still apply.
- Hardship withdrawals. Certain unreimbursed medical expenses, including some long-term care costs, may qualify for a hardship withdrawal if your plan permits them.
How Long-Term Care Costs Can Impact Your 401(k) Balance
Long-term care is one of the largest potential expenses in retirement. Therefore, using your 401(k) to fund it can significantly affect your account balance. Understanding the scale of these costs and how withdrawals compound over time helps with more realistic long-term care planning.
The cost of long-term care varies widely depending on the level of care, location and length of need. Consider these costs, based on the latest national data.
Typical Costs for Long-Term Care
These figures can climb quickly in higher-cost regions, and needs for care often span multiple years.
Every dollar you withdraw from your 401(k) is a dollar that’s no longer compounding tax-deferred. A $100,000 withdrawal at age 70 could mean sacrificing significantly more in future growth, depending on investment returns and your time horizon.
This opportunity cost is easy to overlook in the moment. However, it can substantially shrink the balance available for other retirement needs.
Because traditional 401(k) withdrawals are taxed as ordinary income, the gross amount for withdrawal is larger than the actual expense. For example, covering $80,000 in annual care costs may require withdrawing $100,000 or more, depending on your tax bracket.
This extra amount further depletes your balance and can push you into a higher bracket, increasing taxes on other income sources.
Alternatives to Using Your 401(k) for Long-Term Care Costs
Tapping your 401(k) isn’t the only way to cover long-term care expenses. And, in many cases, other options can be more tax-efficient or better suited to your financial situation.
Exploring alternatives early gives you time to build a strategy that protects your retirement savings while still ensuring quality care. Consider some of the following:
- Veterans benefits. Eligible veterans and their surviving spouses may qualify for the VA Aid and Attendance benefit. This provides monthly payments to help cover long-term care. 6
- Long-term care insurance. A traditional long-term care insurance policy can cover a significant portion of care costs, from in-home assistance to nursing facility stays.
- Hybrid life insurance policies. Hybrid policies combine life insurance with a long-term care benefit. This allows you to access the death benefit if care is necessary.
- Health savings accounts (HSAs). HSAs offer triple tax advantages, and you can use them to pay qualified medical expenses. This includes some long-term care premiums and services.
- Taxable brokerage accounts. Drawing from a taxable account can be more tax-efficient than a traditional 401(k). This is because only the gains are taxed, and often at lower capital gains rates.
- Roth IRA withdrawals. Qualified Roth IRA withdrawals are tax-free. This makes them an efficient source for funding long-term care.
Tax Considerations to Know
Distributions
Distributions from a traditional 401(k) are taxed as ordinary income at your marginal tax rate. This means a large withdrawal to cover care costs could push you into a higher tax bracket, increasing the effective cost of every dollar you take out. Spreading withdrawals across multiple years can help keep more of your distribution in lower brackets.
Early Withdrawals
If you’re under 59 ½, withdrawals from your 401(k) typically incur a 10% early withdrawal penalty on top of regular income taxes.
Limited exceptions exist, including the rule of 55 and certain hardship withdrawals. However, long-term care premiums on their own don’t generally qualify for penalty relief.
For younger savers, this penalty can make 401(k) withdrawals an expensive source of funding.
Social Security
Large 401(k) withdrawals can increase the portion of your Social Security benefits subject to federal income tax. Depending on your total income, up to 85% of your benefits could become taxable. Coordinating withdrawals carefully can help minimize this effect and preserve more of your retirement income.
State Taxes
State tax treatment of 401(k) withdrawals and long-term care expenses varies widely. Some states offer additional deductions or credits for care-related costs.
A few states also tax retirement income differently from the federal government, potentially affecting your overall strategy.
Bottom Line
Long-term care premiums can be a significant expense, so many retirees and pre-retirees look to their retirement account as a potential funding source. Using your 401(k) to pay for long-term care is possible, but it requires careful planning to manage tax implications and protect retirement savings. Traditional 401(k) withdrawals are taxed as ordinary income and can trigger penalties if taken before age 59 ½, while Roth accounts offer more flexibility through tax-free qualified withdrawals.
Long-Term Care Planning Tips
- Many financial advisors specialize in helping people plan for long-term care needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Do your research when looking into long-term care insurance providers. You can start by checking out SmartAsset’s list of the best long-term care providers.
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