Financing Long-term Care in the US: Encouraging Personal Savings through Tax-advantaged Plans

• Financing long-term care is a major and almost inevitable expense, which Americans must prepare for.

• The government can encourage long-term care planning by providing a tax-advantaged savings and investment option.

This is the second of a series on financing long-term care in the US. In part one, we provided a brief overview of the long-term care landscape and the critical financing issues that the US faces. We also review how other countries finance long-term care. In the present and later posts, we examine the implications of various proposed funding options. We obviously have a preference: use health savings accounts (HSAs) to finance long-term care and we will explain why this is the best option.

In part one of this series on long-term care, we noted that the typical American would need $163,000 for long-term care support services (LTSS), and two-thirds of Americans aged 65 years now will need them in future. This is not a trivial amount, especially considering that the average person has about $400,000 in retirement savings by 65. Currently, the cost of LTSS is divided between private and public resources. However, it continues to be a concern among many families. LTSS is a major expense that individuals must plan for as we do any other life occurrence. Therefore, I believe the key to effectively financing long-term care is a combination of financial education and tax-advantaged investment instruments.

Let’s recall that there are a few options available for financing long-term care: 1) personal funds, 2) public financing, 3) long-term care insurance, and 4) life insurance riders. Today’s post focuses on making effective use of personal funds.

First, I would reiterate that the federal government must be responsible for people who need LTSS due to disability or mental health, and as a result are unable to earn enough to survive, let alone save for future expenses.

Just as we encourage young people to plan for their retirement through tax-advantaged individual retirement accounts or workplace 401(k) accounts, they should plan for LTSS expenses and be given the necessary tools when they start work. The government has an interest in ensuring that individuals do not become destitute in old age, so we use tax policy to encourage saving for retirement. Similarly, paying for LTSS being a near-certain expense requires individual agency. But Americans, and humans in general, are not forward thinking without external constraints. A combination of tax incentives and financial literacy training could help individuals better plan for paying for LTSS. I believe a separate long-term care savings account (LTCSA) should be part of the typical cafeteria-style benefits plans open to all, not just employees. The implementation of such a system could be modeled after the popular health savings account (HSA) program but without the onerous limitations such as requiring enrollment in a high-deductible health plan.

Why are LTCSAs preferred to LTC insurance?

I see three reasons.

First, the 40% or so of Americans who end up not needing LTSS get to keep their savings and pass them on as inheritance. Building and maintaining generational wealth is important. The average LTCI premium would be invested like 401(k)s. According to one estimate, the value of an HSA with maximum contributions of which only half is invested would be $250,000 in 25 years. (In fact, this is a strategy I subscribe to; I personally keep expenditures from my HSA to a minimum while maximizing contributions). This value is more than the current estimates for LTC needs. With Americans in control of their funds, they will choose the types of services that are most suitable for themselves.

This leads directly to the second, and perhaps the more important reason LTCSA is preferable to LTCI: in the long run, the cost of LTCSA to the federal budget would be less than direct expenses for LTSS. In 2021 for example, deductions for HSAs cost $10 billion (see page 160, line 124). Even contribution limits for LTCSA at HSA levels would not break the budget.

Third, using personal funds would avoid the moral hazard problem in healthcare caused by health insurance. One of the major successes of current policies, including the Affordable Care Act (ACA), is the emphasis on home and community-based services (HCBS) as an alternative to institutional care, a trend that started before the implementation of the ACA. As more states have adopted managed long-term care support services, often with Medicaid insurance companies, the share of HCBS in LTSS keeps growing, while that of institutional care (e.g., nursing homes) has declined.

However, using LTCSA to finance personal LTSS has some drawbacks.

First, it would require Americans to start saving early. Currently not all Americans even save up to the maximum 401(k) contribution limit. One could argue that instead of a new tax benefit, Americans should simply save more in their retirement accounts. Under that scenario, LTSS, especially those not related to end-of-life care, could be just part of the regular post-retirement expense. There are merits to this argument and, frankly, as someone who prefers light-touch regulations, this is not a bad option. Only 41% of workers contribute to 401(k) even though nearly 70% have access to it. In 2016, as many as 48% of American households aged 55 and over had no retirement savings. In effect, the option for tax-advantaged funding of LTSS could end up benefiting only those with extra income to save. But the point about using LTCSA isn’t only about accumulating money specifically for LTSS but to encourage young people, and in fact everyone, to start thinking about a near-certain expense.

Second, it would require legislative action from Congress, and unfortunately getting major policy changes through Capitol Hill can be difficult. What would eventually emerge might include unnecessary restrictions that may render it ineffective.

Financing long-term care is a big challenge, and what is proposed in this post might not be the best option for everyone, but the key to this proposal is that individuals must start planning for long-term care as early as possible. In the next post, I will be taking a trip around the world to explain the main financing models.