Congress created individual retirement accounts to encourage long-term saving and investing. A traditional IRA rewards you with tax deductions on contributions and with tax-deferred earnings. You must pay income tax on withdrawals, and the IRS might slap a 10 percent penalty on money removed before age 59 1/2. Withdrawals used to pay for long-term care insurance are not exempt from the early distribution penalty.
The IRS offers several exceptions to the early withdrawal penalty. A few are medical-related, but none apply to long-term care insurance. The IRS won’t penalize withdrawals for family medical bills in excess of 10 percent of your adjusted gross income. If you’re 65 or older, this threshold drops to 7.5 percent. If you are unemployed, you can withdraw IRA money penalty-free to purchase medical insurance. No penalty applies if you are permanently disabled. Other exceptions cover qualified education expenses and buying or building a first-time home. Reservists called to active duty also can escape the penalty. If you have a Roth IRA, you can withdraw your own contributions penalty-free to pay for long-term care insurance, but if you withdraw any earnings before age 59 1/2 to pay for long-term care insurance or for another non-exempt purpose, you will have to pay income taxes on the money as well as the 10 percent penalty.
Health Savings Accounts
You might indirectly use IRA money penalty-free for long-term insurance through a one-time tax-free transfer to a qualified health savings account. An HSA provides for tax-deductible savings to cover future healthcare expenses. Some HSAs include long-term care insurance as an option. You can transfer up to the annual HSA contribution limit, which can change yearly. The transfer reduces the year’s allowed contribution to the HSA. If you fail to remain eligible for an HSA plan during the 13-month period beginning on Dec. 1 of the transfer year, you might have to pay taxes and, if applicable, the early withdrawal penalty on the transfer.
You can withdraw a series of substantially equal payments at any age without penalty. The payment amounts are based on your life expectancy, occur at least once a year and follow IRS-approved annuity rules. You can use the withdrawn money for any purpose, including long-term care insurance premiums. You must include the annuity payments in your taxable income. You can look up your life expectancy in IRS Publication 590 and combine it with that of your beneficiary to reduce the required annual payments.
Long-term care insurance can help pay for nursing homes, hospice care and other assistance. The National Association of Insurance Commissioners recommends some common-sense shopping tips for this insurance. It suggests you comparison shop several companies and check each provider’s rate-hike history and financial stability. Resolve any confusion before buying, and rely on the policy language, not advertising or a salesperson’s pitch, to understand the product. Policies normally provide a “free-look period” in which you can change your mind and get your money back.
- Internal Revenue Service Publication 590: Individual Retirement Arrangements
- Internal Revenue Service: Retirement Topics - Exceptions to Tax on Early Distributions
- The National Association of Insurance Commissioners: A Shopper’s Guide to Long-Term Care Insurance
- Internal Revenue Service Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans
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