Debate: Should the EARN Act Let Savers Tap 401(k)s to Pay for LTCI?

Two professors discuss the merit of a provision allowing penalty-free withdrawals to cover long-term care insurance.

The Senate has released its version of the second round of retirement-related reform provisions that are expected to be considered before year-end. In its current form, the Enhancing American Retirement Now (EARN) Act would allow retirement savers to withdraw up to $2,500 in retirement plan assets each year to cover the cost of long-term care insurance premiums without paying the otherwise applicable early withdrawal penalties. These withdrawals would continue to be subject to federal income tax.

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about the narrow provision allowing penalty-free withdrawals to cover long-term care insurance.

Below is a summary of the debate that ensued between the two professors.

Their Votes:

Byrnes

Bloink

Their Reasons:

Byrnes: Long-term care is probably the most costly expense that retirees will face — and there’s no way to know when the need for care will arise. Allowing taxpayers to access their hard-earned retirement funds to cover those costs via the insurance route without penalty makes absolute sense. We shouldn’t be penalizing Americans for covering the cost of care that Medicaid would otherwise be forced to cover.

Bloink: Frankly, this provision doesn’t go nearly far enough. Americans are spending hundreds of thousands of dollars on long-term care and insurance. They should be able to access their retirement savings penalty-free without limit to cover these costs. This narrow provision doesn’t make a dent in the needs of the ordinary American struggling under the weight of LTC costs.

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Byrnes: We need to take steps to encourage Americans to proactively purchase long-term care insurance to provide for their own need for care later in life. This bill does exactly that. For many, retirement savings are the only means of covering these costs. 

Bloink: I also take issue with the fact that the early withdrawals can be used only to cover the cost of long-term care insurance premiums — which are often prohibitively expensive. There are many different ways to cover the cost of long-term care. An increasingly popular insurance option is the hybrid long-term care insurance/annuity product. Some of these products cost far more than the meager $2,500 limit contained in the EARN Act.

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Byrnes: The fact is, we have to limit the amount of retirement savings that can be withdrawn penalty-free. To do otherwise would give Americans license to raid their retirement accounts, which receive tax preferences only because those funds are likely going to be tied up for decades, earning interest while the account owner continues to save. Yes, long-term care insurance is expensive. That doesn’t mean that we must provide a tax-preferred way to allow taxpayers to purchase just any insurance policy.

Bloink: While I do understand that we can’t allow savers to access their retirement funds penalty-free and without limit, the proposed $2,500 limit is likely not based in reality for anyone except the healthy 40- or 50-year-old saver. For older savers, the cost of long-term care insurance may be much higher. And this provision isn’t going to do much to encourage younger savers to purchase insurance that many can’t imagine needing in the future.

We need to allow older Americans to cover the entire cost of their insurance without limit — and find ways to attract younger savers to hybrid products that contain more attractive features for those who fear the opportunity costs associated with buying long-term care insurance at a relatively young age.

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