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Bill would allow tax-free 401(k), IRA withdrawals to buy long-term care insurance

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The measure, which would eliminate income tax and the 10% early withdrawal penalty, could boost the pool of Americans seeking private insurance.

A bill currently being discussed in Congress would allow retirement savers to tap assets held in 401(k) plans and individual retirement accounts tax-free to buy long-term care insurance, with the aim of making the insurance more affordable and potentially driving down premiums for customers.

Sen. Patrick Toomey, R-Pa., plans to introduce a bill in the coming weeks or months that would amend the federal tax code to allow the withdrawal of up to $2,000 of retirement assets annually to pay long-term care insurance premiums and other policy charges. The withdrawals wouldn’t be subject to income tax, and the $2,000 cap would be indexed for inflation.

And if savers younger than 59½ withdrew assets for this purpose, they would not be assessed the typical 10% penalty for early withdrawals.

Mr. Toomey is currently distributing a discussion draft of the legislation and soliciting input from other members of Congress and the general public, said Steve Kelly, his communications director. The bill’s final form could change.

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The bill comes as increasing longevity boosts the number of Americans who need some form of long-term care during their lifetime. Health and Human Services estimates 52% of Americans turning 65 today will develop a disability serious enough to require long-term care services, such as a nursing-home stay or a home health aide.

And those services can be expensive. The median U.S. cost for a month’s stay in a private room in a nursing home is $8,517, according to insurer Genworth Inc. The median monthly cost for an assisted living facility is $4,051, and $4,385 for a home health aide.

While most Americans will only require assistance for two years or less, one in seven will need care for more than five years, according to the Department of Health and Human Services.

Paying out of pocket and using government funding through Medicaid are the most popular ways to pay for long-term care, at 52% and 34%, respectively. Only 2.7% paid for claims with private insurance, according to HHS.

“The market for long-term care insurance is rather narrow and defined,” said Jesse Slome, executive director of the American Association for Long-Term Care Insurance. “But this [bill] is a great thing because it will help encourage the expansion of people who buy it.”

As drafted, the bill would encourage Americans ages 50 to 59 to consider buying long-term care insurance, especially as a result of the removal of a 10% early withdrawal penalty for retirement accounts.

It can be beneficial for individuals to buy the insurance in their 50s or early 60s because it’s often easier to qualify for the insurance at younger ages, when people are typically healthier, Mr. Slome said. The list of medical issues for which insurers can deny coverage to applicants has grown, and the chances of incurring these health conditions increases the older people get, he added.

A single 55-year-old male paid an average $2,050 in annual long-term care insurance premiums in 2019, according to AALTCI. A 55-year-old female paid an average $2,700.

Sales of traditional long-term care insurance policies have fallen more than tenfold over the past two decades, to roughly 58,000 policies sold last year. That’s partly a reflection of negative consumer sentiment in the marketplace after many insurers raised premiums for existing policy holders.

Some financial advisers have shown a preference for so-called hybrid policies that bundle life insurance and long-term care benefits.

The Toomey bill would allow savers to use retirement assets toward a qualified long-term care insurance policy as defined in Section 7702B(c) of the tax code.