Should You Pay For Long-Term Care With Your IRA? {Tax Impact}

If most of your retirement savings are in a traditional IRA, you may be concerned about what would happen if you needed to withdraw a substantial amount to pay for long-term care.

After all, traditional IRA withdrawals are generally subject to ordinary income taxes. So if you suddenly needed an additional $100,000 or more to cover care expenses, wouldn't that create an enormous tax bill?

Not necessarily.

What many retirees don't realize is that qualifying long-term care expenses can be tax-deductible. Those deductions can offset a substantial portion of the taxable income created by IRA withdrawals.

Let's look at an example.

Will IRA withdrawals to pay for long-term care create a large tax bill?

Consider a 67-year-old retiree who has done a good job of saving for retirement.

Like many retirees, most of her savings are in pretax retirement accounts.

She's concerned that if she ever needs long-term care, withdrawing additional money from her IRA could create a substantial tax burden.

It's a reasonable concern. But the tax impact depends on more than how much money she withdraws.

It also depends on whether her long-term care expenses qualify for a medical expense deduction.

An example of paying for long-term care with an IRA

In the video, I walk through two scenarios using hypothetical figures and 2024 federal income tax rules.

In the first scenario, our retiree doesn't need long-term care.

She receives:

$36,000 annually in Social Security benefits.

$113,000 annually in traditional IRA withdrawals.

Approximately $143,600 in adjusted gross income, including the taxable portion of Social Security.

Her estimated federal income tax is approximately $23,500.

Now let's assume she needs substantial long-term care the following year.

To cover those expenses, she increases her IRA withdrawals from $113,000 to $252,000.

That's an additional $139,000 withdrawn from her IRA.

You might expect her federal income taxes to increase dramatically.

But in this example, her estimated federal income tax rises to approximately $34,500.

That's an increase of only about $11,000 despite withdrawing an additional $139,000.

Why isn't the tax increase much larger?

The answer is the medical expense deduction.

How does the medical expense deduction work?

The IRS allows you to deduct qualifying, unreimbursed medical expenses that exceed 7.5% of your adjusted gross income when you itemize deductions on Schedule A.

In our example, the retiree has approximately $283,000 in adjusted gross income during the year she needs long-term care.

Here's how the calculation works:

Adjusted gross income: $283,000

7.5% of adjusted gross income: $21,225

Qualifying medical expenses: $131,000

Potential medical expense deduction: $109,775

That means she can deduct approximately $110,000 in medical expenses, assuming the full $131,000 qualifies and isn't reimbursed.

That deduction substantially reduces her taxable income, helping offset the additional IRA withdrawals.

These are historical illustrations using 2024 federal tax assumptions. Actual results depend on the applicable tax rules and individual circumstances.

Are long-term care expenses tax-deductible?

Yes, qualifying long-term care expenses can be deducted when you itemize, but not every expense associated with long-term care qualifies.

The IRS allows deductions for qualifying medical and long-term care services, including:

Skilled nursing care and medical treatment.

Certain nursing home expenses, including meals and lodging when medical care is a principal reason for residing there.

Qualifying in-home nursing and personal care services.

Assistance with activities such as bathing, dressing, eating, and toileting.

Qualifying supervision and care for someone with severe cognitive impairment, such as Alzheimer's disease.

For qualified long-term care services, a licensed healthcare practitioner must certify that the individual is chronically ill, and the services must follow a prescribed plan of care.

A person can qualify by needing substantial assistance with at least two activities of daily living for an expected period of at least 90 days, or by requiring substantial supervision because of severe cognitive impairment.

Ordinary living expenses, such as rent, meals, housekeeping, and personal services unrelated to qualifying care, generally aren't deductible.

Assisted living and memory care expenses require a closer look. Qualifying care services can be deductible, and certain facility charges, including meals and lodging, can also qualify depending on why the person resides there.

The key is understanding which expenses meet IRS requirements rather than assuming every dollar spent on long-term care is deductible.

Does this mean you don't need long-term care insurance?

No. Long-term care insurance can still be an appropriate part of a retirement plan.

But it's not the only way to prepare for potential care expenses.

Some retirees have sufficient investments and other assets to pay for care themselves. Others prefer to transfer some of that financial risk to an insurance company.

The decision depends on your financial resources, insurance options, and how paying for care would affect the rest of your retirement plan.

And remember, a tax deduction doesn't reimburse you for the cost of care. You're still spending the money, even if the deduction reduces your tax bill.

How should you plan for long-term care expenses in retirement?

Before deciding how to fund potential long-term care expenses, it's important to understand how those costs would affect your overall financial picture.

That includes where your retirement savings are held, the taxes associated with withdrawals, available insurance benefits, and potential medical expense deductions.

You also need to consider how larger IRA withdrawals could affect Medicare premiums and other parts of your retirement income plan.

The bottom line: Paying for long-term care with money from a traditional IRA doesn't automatically mean you'll face an enormous income tax bill.

Qualifying medical expense deductions can substantially reduce the additional federal income taxes associated with those withdrawals.

Understanding how these rules work can help you make better decisions about preparing for long-term care and how it fits into your overall retirement plan.

For more information, see IRS Publication 502, Medical and Dental Expenses.

Full Transcript:

(00:01):

I am going to share an example of what it might look like if you had to pay for long-term care expenses from the money that's in your IRA. So recently I've been working with a lady, she's recently retired, she's now 67 years old. Like a lot of retirees that have done a great job of saving most of her money is now in pre-tax retirement accounts. And at one point in our discussions, we were talking about long-term care and she commented that if she did need long-term care that she would probably just get killed in taxes. And I mentioned to her that no, that probably wouldn't be the case because you could itemize and she didn't understand really what the impact would be or how that might look. I shared that with her and I also want to share that here with you in case you have any questions about this because this I feel is so important in the case with this lady in particular.

(00:52):

I think in the past she was led to believe that if she needed long-term care, that her IRA would just be crushed. And it's not to say that couldn't happen to somebody. It depends on how much you might actually have in savings in your IRA, but I think it was kind of told to her as a way to make her feel like she needed to buy long-term care insurance. And that would be the only solution. And I'm not saying that long-term care insurance isn't a good tool to have for some people it absolutely is. It's just another tool in the toolkit, so to speak. But it's important to understand the facts and how these things work and when doing, planning for retirement and understanding taxes and all these types of things. Let's go ahead and dive in. I'll share a real quick example with you and show you how this works if she were to itemize in a year that she needed long-term care expenses.

(01:42):

So first of all, we'll take a look at a year in which she does not need long-term care. So we'll say here, 2024, she doesn't need long-term care and these aren't her numbers. I just made up some sample figures here just for our purposes. So let's say this person has $36,000 in Social Security benefits here. They've got $113,000 coming in from an IRA, so their total AGI, because not all the Social Security is subject to tax is $143,000. So on the federal level, which by the way, we're only looking at this on the federal level, I want to keep this simple. And in fact I'm just going to assume here that she lives in a state that doesn't even have state income tax. So down here you'll see $23,000 is the total amount of tax. Now pay attention right here to this. She's right now taking the standard deduction, she doesn't have enough itemized deductions for her to itemize. So she just takes the standard deduction. But now let's say next year, she did need long-term care. So next year she's now withdrawing $252,000 out of that IRA, remember the year before she was taking only $113,000. So $252,000 now out of the IRA. And so you go all the way down to the here to the bottom and you'll see taxes only went up by a little bit, about $10,000 or so.

(03:03):

There is now $34,000 in federal taxes. And so why is that? Well, it's very simple. It's just because she was able to itemize and her itemized deduction is now about $110,000. Let's take a peek at the Schedule A. You'll see right here, the way that that works, she's 67 years old, remember? So what she can do is we take a look at her total AGI for the year $283,000, multiply that by 7.5%. That equals this number, this $21,000 number and anything above that amount can be itemized. So that's this number right here. $131,000 minus $21,000 equals this $110,000 figure. And again, I kept it simple. No other state taxes or anything else like that. So take that $110,000, apply that back here on the front page here of the 1040, and that's what makes that difference so that now she's only paying $34,000 in taxes. Remember again, the year before it was $23,000. So she's withdrawing a lot more money, but only paying a little bit more in taxes. Alright? So it's important to understand how these things work. Hopefully this has been helpful for you. If you had any questions on this, hopefully this cleared up any of those questions, make sure you like the video, make sure you subscribe. I'll see you soon.