Should Federal Employees Self-Fund for Long-Term Care Costs?

A recent column discusses how long-term care (LTC) costs increased significantly from 2019 to 2024, led by a nearly 50 percent increase in home health care and assisted living costs. Annual LTC costs are increasing at a pace greater than the incomes of individuals who are currently paying for LTC including nursing home, assisted living facility, or home health care. That column also discusses actions federal employees are advised to take to prepare for future LTC expenses. These actions include purchasing LTC insurance through the Federal Long Term Care Insurance Program purchasing an individual LTC insurance policy from  a private insurance company.

However, there are disadvantages associated with purchasing LTC insurance. Among the disadvantages:
(1) An applicant has to apply and qualify (can be rejected as part of medical underwriting); and
(2) Premiums can be pricey and unaffordable. This column discusses an alternative for federal employees and retirees for paying future LTC expenses, self-funding.

Advantages of Self-Funding Future LTC Costs

Self-funding for future LTC costs offers flexibility, avoids premium payments and possible restrictions associated with an LTC insurance policy. Another advantage to self-funding is that money saved and accumulated belongs to the individual or married couple who save and invest their money for any future need. This means that if an individual or married couple never incurs a need or a limited need to use the accumulated money to pay for their LTC needs, the remaining money will be passed onto their estate and beneficiaries when they die.

This is different from purchasing LTC insurance. When an individual applies and is approved LTC insurance, the individual must pay insurance premiums. Once the individual incurs a need for LTC which the insurance company approves, the LTC insurance company starts reimbursing the insured for LTC expenses. At that time individual stops paying premiums (this feature is called “waiver of premium”). On the other hand, if an individual was approved for LTC insurance at age 50, paid LTC insurance premiums for 25 years and dies at age 75 without incurring a need for LTC, then 25 years of LTC insurance premiums are kept by the LTC insurance company.

Important Consideration: Who Will Provide LTC During An Individual’s Later Years?

It is important for anyone to consider self-funding to pay future LTC expenses to envision how their future LTC needs will be best served. Decisions about the different types of LTC options – these include LTC in a nursing home, in an assisted living facility, or in one’s home , is an important factor to consider because of the varying costs associated with each option.

Some individuals hope that family members can manage some or all of their future LTC needs. However, it is important for these individuals to be realistic about whether family members (such as adult children) are both willing and capable of supporting the individual in need of LTC. It is also important to understand that caregiving can be emotionally and physically demanding. Caregiving can have a significant effect on the finances of a family member who must take time off from their jobs in order to provide LTC for a family member. In addition, a family member such as an adult child who spends much time taking care of a parent means less time meeting the needs of other family members such as their children.

Many individuals would prefer to remain in their homes rather than going to a nursing home or an assisted living facility. However, staying in one’s home can be complicated and challenging in case the individual in need of LTC has physical limitations such as walking steps or using a wheelchair. If a house has multiple staircases and narrow hallways, then renovations to adjust the home to accommodate the individual’s LTC needs could be costly.

Assets That Could Be Used for Self-Funding LTC Costs

Individuals who are considering self-funding for future LTC costs will need to identify which of their accounts and assets they will utilize for self-funding future LTC expenses. The decision as to which accounts or assets to use can have income tax and liquidity implications. A high net worth does not necessarily mean all of one’s assets are candidates for self-funding future LTC expenses. For example, if a substantial amount of an individual’s wealth is tied up in illiquid assets (such as real estate), then the individual may not have the time or the ability to sell these assets should a health crisis suddenly occur. Another potential problem when highly appreciated assets are sold are the tax consequences. The resulting long-term capital gain requires the asset owner to pay capital gains taxes at the federal level, and in states with state and local taxes, at the state level. The resulting taxes that are paid can potentially reduce the amount of funds that can be used to pay for LTC expenses.

The following are some suggestions for self-funding to pay future LTC expenses:

1. Using Health Savings Accounts. Money invested in a health savings account (HSA) is a good choice for paying future LTC expenses. Contributions to an HSA are tax-deductible and contributions accrue earnings. Both contributions and accrued earnings can be withdrawn tax-free to pay for qualified medical expenses. LTC expenses generally qualify as health care expenses. Also, tax-free withdrawals can be from an HSA to pay LTC insurance premiums.

2. Withdrawing assets from a brokerage or a traditional retirement account. Withdrawing liquid assets (for example, money market account funds) from a brokerage account or from a traditional retirement account (such as a traditional TSP or a traditional IRA) may allow the brokerage account owner, traditional IRA owner or traditional TSP participant to take a deduction for medical expenses. Medical expenses include LTC expenses to the extent that the total amount of medical expenses exceeds 7.5 percent of the individual’s or couple’s adjusted gross income (AGI). For example, a married couple filing jointly with an AGI of $200,000 could potentially deduct LTC expense exceeding 7.5 percent of $200,000, or $15,000 that year. The $15,000 could be the amount the couple spends during a single month stay in a nursing home.

3. Using Roth Accounts – Roth TSPs and/or Roth IRAs. A Roth account in which all qualified withdrawals are income-tax free is ideally suited to pay future LTC expenses for the following reasons: (1) Federal employees can contribute each year via payroll deduction to the Roth TSP with no income restrictions;(2) Starting in 2026, federal employees and retirees can convert portions of their traditional TSP accounts to the Roth TSP; (3) Over the years many federal employees and retirees have contributed to Roth IRAs and/or converted some of their traditional IRAs to Roth IRAs; and (4) Both the Roth TSP and the Roth IRA are not subject to required minimum distributions (RMDs). A Roth TSP participant and a Roth IRA owner upon reaching their required beginning date (currently age 73) do not have to withdraw from their Roth account. In other words, a Roth account can continue to grow tax-free over time. This tax-free compounded growth of a Roth account could result in a huge tax-free retirement “nest egg” in which tax-free withdrawals can be made at any time to pay LTC expenses. Consider the following example:

Jerome recently retired from federal service at age 60. He has a Roth TSP account currently worth $100,000. Jerome is married to Olivia, age 58, who has a Roth IRA currently worth $75,000. Jerome and Olivia have no plans to withdraw from their Roth accounts. Their plan is to self-insure for future LTC expenses using their Roth accounts. Assuming that their Roth accounts are growing at an annualized investment return of 8 percent and both Jerome and Olivia will need to pay for LTC in 22 years, (when Jerome is 82 and Olivia is 80) the value of their Roth accounts is shown in the following table:

When Jerome becomes 82 and if he needs to go into a nursing home, he has accumulated over a half million dollars in his Roth TSP account. There should be an amount in his Roth account (that can be withdrawn tax-free)to pay (in today’s dollars) for a 3 to 4 year stay in a nursing home of Jerome’s choice. Olivia will have an amount in her Roth IRA (that can be withdrawn tax-free) to pay (in today’s dollars) for a 2 to 3 year stay in a nursing home. It is important that the Roth accounts do not have to be liquidated all at once to pay LTC expenses. Any funds in the Roth accounts that are not withdrawn continue to grow tax-free. Upon the death of the Roth account owner, any remaining Roth assets will go to a designated Roth beneficiary(ies).

Does An Individual Hope to Leave An Inheritance for Family Members?

Given the unpredictability and potential LTC expenses in the future, self-funding LTC can directly affect the goals for family or charitable gifting. It is important for individuals to have conversations with family members about their expectations and hopes for the individual’s later-in-life health care. An important part of the discussion with family members is how self-funding a potential LTC even may impact the individual’s legacy plans.