Workers may have a new way to help prepare for a largely unpredictable health-related expense during their golden years. Under a new rule now in effect, 401(k) plans are permitted to let participants take limited penalty-free withdrawals to pay for long-term care insurance, which covers the cost of assistance with daily living activities such as bathing, dressing and eating — and often is needed later in life.
Understanding the New Rule
The new rule was included in 2022 retirement legislation known as Secure Act 2.0, and had a delayed effective date of three years, or Dec. 29. However, it comes with limitations. Experts say it’s essential to consider whether using retirement money to pay for long-term care insurance makes sense — or if you should purchase a policy at all. “The [rule] is there for people, but it might not be practical to use it,” said Carolyn McClanahan, a physician and certified financial planner based in Jacksonville, Florida.
Costs of Long-Term Care
If you reach your 65th birthday, you have about a 70% chance of needing some form of long-term care services and support, according to a 2020 estimate from the U.S. Department of Health & Human Services. On average, women who require care need it longer — 3.7 years, versus 2.2 years for men. While a third of 65-year-olds will never need long-term care, 20% will end up requiring it for more than five years. The cost of a home health aide reached an annual median cost of $77,792 last year, up 3% from 2023, according to the 2024 Cost of Care survey conducted by Genworth Financial.
Insurance Premiums and Options
For a pure long-term care policy, a 55-year-old male with $165,000 of coverage and a 3% yearly inflation protection — meaning the benefit grows by that amount yearly — would pay an average annual premium of $2,200, according to the American Association for Long-Term Care Insurance. Many people end up purchasing a hybrid policy, which is typically a life insurance contract with a long-term care rider. In other words, there is some coverage for care costs, but there is also money passed on to a beneficiary if you don’t use any or all of the long-term care benefits.
Secure 2.0’s New Rule Limits
While companies and insurers await guidance from the IRS on the precise parameters and application of the provision taking effect for penalty-free withdrawals, there are some known limits. For starters, not all 401(k) sponsors — i.e., employers — will allow this in their plan. The withdrawal is limited to the cost of your annual insurance premium, up to $2,600 for 2026 (indexed yearly for inflation). However, the amount you take out cannot be more than 10% of your balance.
Considering the Implications
Additionally, while the money you pull wouldn’t be subject to the 10% early withdrawal penalty that usually applies to distributions taken before age 59½, it would still be subject to ordinary income tax rates. So, if you withdrew $2,600, you’d avoid paying a $260 penalty (10%). The exact amount of tax you’d owe would depend on your tax bracket. Taking money from your retirement account also means removing assets that would have continued tax-deferred growth.
Learn more about the new rule and its implications Here
Smart Tip for Readers
When considering using your 401(k) to pay for long-term care insurance, make sure to weigh the potential benefits against the potential costs and tax implications, and explore all available options for covering long-term care expenses to make an informed decision that suits your financial situation and goals.
