Secure 2.0 rule allows early 401(k) withdrawals for LTC insurance

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 — and often is needed later in life. 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 important to consider whether using retirement money to pay for long-term care insurance makes sense — 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. She is a member of CNBC’s Financial Advisor Council.

Typically, withdrawals before age 59½ incur a 10% penalty, as well as ordinary taxes. There are already some exceptions when the penalty doesn’t apply, including for qualified birth or adoption, certain unreimbursed medical expenses and the so-called rule of 55, which applies if you leave your company in the year you turn age 55 or later.

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 — 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.

However, Medicare — which is most people’s health coverage starting at age 65 — generally does not cover such care. While unpaid family members often serve as caregivers for stretches of time, more formal arrangements can become necessary — and those paid options can be expensive.

For example, 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. The national annual median cost of a semi-private room in a nursing home rose to $111,325, up 7% from 2023. For a private room, the median yearly cost climbed 9% to $127,750. 

The options for covering these unpredictable costs range from self-insuring — you are wealthy enough to pay out of pocket when and if those expenses arise — to qualifying for Medicaid, which covers some forms of long-term care for individuals who have little to no financial resources.

For people in between the two extremes, some form of insurance is more common, said McClanahan, the founder of Life Planning Partners. However, she said, the claims process can be laborious for traditional long-term care policies, and the premiums for good coverage tend to be pricey.

For a pure long-term care policy, a 55-year-old male with $165,000 of coverage and a 3% yearly inflation protection — meaning the benefit grows by that amount yearly — would pay an average annual premium of $2,200, according to the American Association for Long-Term Care Insurance. For a policy with a 5% yearly benefit growth, the cost would be $3,710 annually. 

Women, who tend to live longer, face steeper pricing. A 55-year-old woman pays an average of $3,750 yearly for a $165,000 coverage and 3% yearly growth. For 5% benefit growth, the policy would cost $6,400 annually, according to the association.

Insurers can hike premiums from year to year.

Many people end up purchasing a hybrid policy, McClanahan said. This 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.

In contrast, pure long-term care policies come with no guaranteed payout — if you die without having used any or all of the benefits of the insurance, the money you paid into it via premiums is effectively gone.

“The traditional policies cost a lot of money, and people don’t want to go into them because it goes away when you die,” McClanahan said. “The coverage with a hybrid policy is not as rich as a straight long-term care policy, but it’s still a bucket of money that can be accessed for long-term care.”

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 — i.e., employers — will allow this in their plan. It’s not mandatory, and it might take some time for meaningful adoption, said Alexander Papson, a CFP and manager of fiduciary solutions for Schneider Downs Wealth Management Advisors in Pittsburgh.

“Just because it’s out there as an option to make this allowable doesn’t mean that every [plan] has gone through the process of amending their plan documents to allow it,” Papson said.

If allowed, 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. So, if you have $20,000 in your account, you would be limited to withdrawing $2,000.

Additionally, while the money you pull wouldn’t be subject to the 10% early withdrawal penalty that usually applies to distributions taken before age 59½, it would still be subject to ordinary income tax rates, said Bradford Campbell, a partner with law firm Faegre Drinker Biddle & Reath in Washington, D.C.

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. For someone in the 12% bracket, that would mean owing $312 in taxes, while a person in the 32% bracket would have a $832 tax bill.

However, someone in the 12% bracket may not really be able to afford the premiums anyway, and the person in the 32% bracket could likely afford the premiums without touching their retirement savings, McClanahan said. Taking money from your retirement account means removing assets that would have continued growing tax-deferred.

Additionally, there is some uncertainty over whether the full premiums for a hybrid policy would qualify, or just a portion of the premium that covers a long-term care rider.

There will also be requirements related to providing proof from the insurance company that you have paid premiums for a qualifying insurance policy.