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 \u2014 and often is needed later in life.<\/p>\n
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 \u2014 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.<\/p>\n
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 \u2014 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.<\/p>\n
For a pure long-term care policy, a 55-year-old male with $165,000 of coverage and a 3% yearly inflation protection \u2014 meaning the benefit grows by that amount yearly \u2014 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.<\/p>\n
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 \u2014 i.e., employers \u2014 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.<\/p>\n
Additionally, while the money you pull wouldn’t be subject to the 10% early withdrawal penalty that usually applies to distributions taken before age 59\u00bd, 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.<\/p>\n