Of course you can use IRA assets later for care. The better question is which assets are the best ones to use for a spouse's or your own future care costs.
Using IRA assets can be a very tax-efficient way to use those taxable dollars, because the high cost of care is quite likely to make those IRA distributions mostly tax deductible. Care at $100,000 or more a year in the future will probably exceed the 7.5% threshold for medical deductions. Taking $100,000 out of the IRA, then deducting the out-of-pocket care costs, might wipe out most of the tax on that distribution. We like that.
The mistake I see is making it only about that one strategy. IRA or long-term care insurance is not the choice. It is probably both. The comparison falls into three categories: diversification, asset depletion, and leverage.
Diversification
Relying on one strategy, especially one that depends on today's tax law, is risky. Will the IRS still let care costs offset IRA income? Will the 7.5% hurdle become 20% or 50%? Unlikely, but we don't know. The right question is not which idea is better. It is what the overall plan is.
For people with substantial IRA assets, the likely plan has three parts. Use IRAs, and probably some cash, to access those taxable assets in a tax-wise way when care costs arise. Use surplus income, if there is any, knowing that spending the IRA will also reduce the income it produces. And use insurance-company dollars: leveraged, tax free, and easier for a spouse or adult children to spend than money the family thinks of as legacy.
- A 70-cent dollar. Tax to reach the asset turns the dollar into less than a dollar. That is an IRA withdrawal that does not clear the 7.5% deduction threshold, and it is a non-IRA annuity used to pay care.
- A full dollar. Cash, or an IRA withdrawal that is close to a full dollar because the care costs are deductible against it.
- A leveraged dollar. Two, three, or five times the dollar allocated. That is what a long-term care policy is built to provide.
The leverage math
Here is the illustration I use. $100,000 into a policy that produces a $300,000 pool. A portfolio does not come close to that until at least 10 years of growth, and it would need to grow at 11.6% tax free every year for those 10 years. That is not realistic. At 7% net of taxes and fees, it takes 17 years to grow $100,000 to $300,000. By then the policy pool in this example has moved on, perhaps to $400,000 or more, and catching up takes about 21 years.
Those policy numbers are contractual. The portfolio's are not. A bear market, higher tax rates, or another emergency can put a claim on the self-insured assets. And if care is needed in the first 10 years, the gap is immediate: from day one the policy provides the $300,000 pool, while the same $100,000 left invested is still growing toward it. About 20% of people in care facilities are under 65.
Asset depletion
Sequence-of-returns risk is sharper at a care event than at retirement. You can work longer or delay a trip. You cannot delay the care bill. Taking $100,000, $200,000 or $300,000 a year out of a falling portfolio, year after year, can be enough on paper and still be a nightmare.
Most clients think in terms of required minimum distributions and leaving what remains to family. Watching $2,000,000 become $1,800,000, then $1,500,000, then less than $1,000,000 feels different from the planning meeting where self-funding seemed obvious. Insurance in place leaves the choice of how much to take from assets, how much from income, and how much from the insurance company.
A better plan may be the three-legged stool: use investment assets, use surplus income, and use insurance-company leveraged, tax-free dollars. Not one idea or the other.