Protecting retirement accounts during long-term care

This article is for educational purposes only and does not constitute medical, legal, or financial advice. Every family situation is different, and you should consult with appropriate professionals about your specific circumstances.

Your parent spent decades building retirement savings. 401k contributions taken from every paycheck. IRA rollovers moved carefully from job to job. Investments selected thoughtfully and adjusted over time. That money represented security. The plan was that your parent would retire, live on Social Security and interest, and leave what's left to their kids.

And then your parent needs long-term care. Not a few weeks of physical therapy. Not a month in rehabilitation. Months or years of help with daily living. Eating, bathing, dressing, toileting. And that care costs more than Social Security provides. Your parent starts drawing down savings. Money that took forty years to accumulate disappears in a couple of years to pay for care.

This is the collision between what people plan for and what actually happens. Retirement accounts that were meant to fund a twenty-year retirement suddenly need to fund long-term care. And the rules about those accounts (Required Minimum Distributions, early withdrawal penalties, tax implications) suddenly matter in ways they never did when everything was going according to plan.

The question most families ask at this point is: how do we protect this money? How do we keep long-term care costs from consuming all of your parent's retirement savings before they die? What can we legally do to shelter those assets?

The honest answer is complicated. Some protection strategies are legal and legitimate. Some are the kind of planning that should have happened years ago, and it's too late to do them now. Some strategies that families try are illegal or have unintended consequences. This article walks through what's actually possible, what timing matters, and what you need to know about protecting retirement assets.

Understanding the Basics

Retirement accounts (401ks, IRAs, Roth IRAs, and similar accounts) are treated specially by the tax code and by Medicaid. Understanding why they're protected might help you understand what protection is actually possible and what isn't.

The tax system created these accounts because policymakers wanted to encourage people to save for retirement. The government gave tax breaks to money set aside for retirement. You don't pay income tax on the money going in. It grows tax-free. And you don't pay taxes until you withdraw it. This was intentionally designed to help people accumulate retirement savings.

Medicaid rules treat certain retirement accounts differently than it treats other assets. Some retirement accounts are "exempt" assets, meaning Medicaid doesn't count them when determining whether your parent qualifies for Medicaid. Some retirement accounts are "countable" assets, meaning they do count toward the asset limit. Understanding which is which matters enormously if your parent is approaching Medicaid qualification.

But here's the important part: retirement accounts are still your parent's money. Even if they're exempt assets for Medicaid purposes, your parent can still withdraw money from them. If they withdraw money, they have to pay income tax on it. And in some cases, they also have to pay penalties. The money becomes available to pay for care, but your parent might owe taxes and penalties on the withdrawal.

This creates a tension. On one hand, your parent needs money to pay for care. On the other hand, withdrawing from retirement accounts to pay for care creates tax consequences that further deplete the money. And if your parent has required minimum distributions (amounts they're required to withdraw from their retirement accounts each year), those distributions happen whether they need the money or not, and they pay taxes on them.

The strategy question becomes: how do we use retirement accounts to pay for care in a way that minimizes tax consequences? Or how do we structure things so that retirement accounts are protected from being used for care while other assets are used instead?

Your Parent's Specific Situation

To think about protecting retirement accounts, you first need to understand what retirement accounts your parent has, how much is in them, and what the distribution rules are.

Start by identifying all retirement accounts. Many people have multiple accounts from different employers or different times in their life. There might be a 401k from one job, another 401k or IRA from a previous job, a Roth IRA opened years ago, a Simple IRA or SEP-IRA from self-employment. You might find accounts your parent forgot about. You might find statements going back years showing accounts that have already been rolled over or withdrawn. Gather every statement you can find.

For each account, note the type of account, the current balance, whether it's already started distributions, and who the designated beneficiaries are. The beneficiary designations are important. If your parent has named someone as beneficiary of their retirement account, that's typically who gets the account when they die, regardless of what their will says. So if your parent named you as the beneficiary twenty years ago, the account goes to you, not to the estate, not through probate, not according to their current wishes.

Understand the distribution rules for each account. How old is your parent? Once they reach 73 (as of recent years), they're required to take distributions each year from traditional IRAs, 401ks, and similar accounts. They're not required to take distributions from Roth IRAs until after they die. If your parent isn't yet of age for required distributions, the rules are different. If they've already been taking distributions, those will continue. The amount of the required distribution is calculated based on the account balance and the person's life expectancy.

Figure out what your parent's tax situation is. When they withdraw from a traditional IRA or 401k, they have to include that withdrawal as income on their tax return. That income gets added to whatever else they have (Social Security, pensions, interest) and they owe income tax on the total. For people on limited income, a large withdrawal might push them into a higher tax bracket. It might also trigger taxation of their Social Security benefits or other consequences.

Check whether your parent has ever taken early withdrawals or has early withdrawal penalties. If your parent withdrew from a retirement account before age 59 and a half, they might have paid a 10 percent penalty. Some of those penalties might have been waived in certain circumstances, but your parent's history matters.

Ask whether your parent has taken any of the actions that would be considered a protected plan for long-term care. For example, some people purchase long-term care insurance and fund it with retirement account distributions. Some people have purchased annuities that include long-term care benefits. Some people have created trusts that protect retirement accounts. Understanding whether your parent took any of these steps changes what's possible going forward.

Taking Next Steps

The decisions you need to make depend on where your parent is in the process. Are they facing potential long-term care in the future but not currently receiving it? Or are they already receiving care and burning through money? That changes what's possible.

If your parent is healthy now but might need long-term care in the future, there are planning steps that can be taken. One option is to use retirement account distributions to purchase long-term care insurance. If your parent is insurable (meaning they don't have medical conditions that make them uninsurable) and they're healthy enough to qualify, they can take distributions from their retirement accounts and use that money to buy a policy. This protects them by having insurance pay for care rather than depleting their retirement accounts.

Another option is to consider an annuity with long-term care benefits. Some insurance companies sell annuities that combine retirement income with long-term care coverage. If your parent buys this kind of annuity with retirement account money, a portion of the money they receive goes to cover potential long-term care. This is complex and not right for everyone, but for some people it's a good solution. You'd need to consult with a financial advisor who understands these products to know whether it makes sense.

Some people restructure how retirement accounts are titled or organized. For example, moving money from a countable asset to an exempt asset can help with Medicaid planning. Or setting up trust arrangements for retirement accounts can affect how they're treated. But these strategies are state-specific and require professional guidance. If you think your parent might eventually need Medicaid, consulting with an elder law attorney about how retirement accounts are structured is worth the investment. Doing this planning before your parent needs care is much easier than trying to restructure things after care has already started.

If your parent is already receiving long-term care and needs to start using retirement accounts to pay for it, you need to understand the tax consequences. Work with your parent's accountant or a tax professional to understand what the withdrawal would mean for taxes. In some cases, it makes sense to withdraw large amounts in a year when your parent's income is low, because the marginal tax rate will be lower. In other cases, it makes sense to withdraw small amounts over time to keep taxable income lower. The strategy depends on the specifics.

Think about whether your parent should take distributions in a way that minimizes tax, or whether they should use other assets first if available. If your parent has savings accounts, investment accounts, or other liquid assets that aren't in retirement accounts, using those first might make sense. Those assets don't have required distributions or tax consequences on withdrawal. Keeping retirement accounts intact for as long as possible preserves their tax-preferred status.

Also think about whether your parent has sources of income that would be affected by additional withdrawals. If withdrawing from a retirement account would trigger taxation of Social Security, for example, that needs to be factored in. Your parent's accountant can model different scenarios and show what the tax consequences would be.

If Medicaid qualification is a possibility, the timing and structure of retirement account distributions becomes very important. Medicaid has rules about transfers and spending, and those rules can be affected by how and when retirement accounts are accessed. This is complex enough that it really requires professional guidance. If you think Medicaid might be needed, consult with an elder law attorney about the implications of using retirement accounts for care.

Finally, review the beneficiary designations on all retirement accounts. If your parent has named beneficiaries but their situation has changed, they might want to update the designations. Who they leave these accounts to is determined by who's named as beneficiary, not by their will. So making sure those designations reflect their current wishes is important.

The Bigger Picture

The reality is that most retirement savings can't actually be protected from long-term care costs without planning that should have happened years before. The strategies that work (purchasing long-term care insurance, restructuring accounts, setting up trusts) work best when done well before care is needed. Once someone is already receiving care and money is being spent, the window for most protection strategies has closed.

What can be protected is knowledge and careful decision-making. You can educate yourself about the rules. You can work with professionals who understand the implications. You can make intentional choices about what to withdraw, when to withdraw, and how to minimize tax consequences. You can be strategic about the order in which different assets are used.

The larger truth is that long-term care is expensive, and retirement accounts that are meant to last a lifetime often don't last when long-term care enters the picture. That's not your parent's fault or your fault. That's a reality of current healthcare costs and the way our system is structured. But understanding how it works and making good decisions about it can help protect more of what your parent has and reduce unnecessary tax consequences.

If your parent is fortunate enough to have been able to plan ahead, they might have insurance or other arrangements in place. If they haven't, the focus is on managing what's there as well as possible. Either way, having a professional who understands retirement accounts, tax implications, and potentially Medicaid rules involved in the decision-making process is worth the cost. It prevents expensive mistakes.

How To Help Your Elders is an educational resource. We do not provide medical, legal, or financial advice. The information in this article is general in nature and may not apply to your specific situation. If you are concerned about a loved one's cognitive health or safety, consult with their healthcare provider or contact your local Area Agency on Aging for guidance and support.

How To Help Your Elders is an educational resource. We do not provide medical, legal, or financial advice. The information in this article is general in nature and may not apply to your specific situation.