The worrying connection between long-term care insurance and the Roth IRA

Cherry BlossomPhoto courtesy of Mark Elliot

I talked last time about long-term care insurance (LTCI), and how it can be a great tool to hedge against the incredible medical costs of things like nursing home care.

This is, of course, assuming that the insurers stay in business, which they don’t always do.

Perhaps this is a bit of a mental leap, but reading about the struggles in the LTCI market made me think about our Roth IRAs. In both cases, the products come down to one thing:

Trust.

But is that trust valid?

Trust me

Insurance relies on trust. We pay premiums year after year, under the belief that should we need to collect on a policy, the insurer will come through.

Without this trust, the market doesn’t work. We wouldn’t pay up, and insurers wouldn’t have the money to pay out anyway.

So it’s important to realize that trust benefits all parties, not just the insured.

Roth IRA refresher

What does long-term care insurance have to do with the Roth IRA? Well, nothing directly.

But on further reflection, the Roth IRA relies on trust too.

As a refresher, the Roth IRA is an retirement arrangement that allows you to contribute money into an account. The money in this account can be invested in various products, but the important thing here is that the money can be withdrawn tax-free. This contrasts with a Traditional IRA, which yield a tax deduction when contributing, but will incur taxes upon withdrawal. (And it also contrasts with a regular investment account, which is taxes at capital gains rates.)

I love the Roth IRA, and think that if you’re eligible to start one, it’s a good idea for you (and it’s not just for tax reasons either). Here’s how to start one.

Now, in all the cases other than the Roth, there is a tax coming in the long-term. You know this and can expect it.

In the Roth IRA, the money that was put into the account has “already” been taxed. Any money I’ve earned, I’ve already paid income taxes on it. I can invest it in a Roth, but that money has already had taxes taken out.

We use a Roth to time-shift our tax obligations. We pay tax now so we don’t need to pay later. This is most obviously used when you believe that your tax liabilities will be higher in the future.

Will we be taxed again?

But back to trust. The Roth IRA is a government arrangement that promises that taxes won’t be owed in the future.

In order for the system to work, we all need to believe that they will honor that agreement.

Not everyone buys it though. There are some who believe that when the government finds itself in a bind, it will renege on its promise and tax you again after all.

How is this different from an insurer promising to pay out, and then going out of business?

Probably not

The biggest difference is that insurance is a private industry and the Roth is government program. And while it’s an unpopular viewpoint in these government-hating days we live in, but I trust the government to look after my own interests way more than I would trust a private entity.

So while yes, it’s true that I could find myself in a situation where my Roth money is double-taxed (once now, once later), I think it’s highly unlikely. Because of the breach of trust, putting aside any legal implications, it would invariably torpedo the program.

And frankly, the Roth is a better money-spinner for the government than the alternative. It gets paid now, versus other products where the payout comes later. It doesn’t seem to make much sense to jeopardize an arrangement where you get paid now rather than later.

Moreover, if things get bad enough that the government feels the need to rewrite its obligations, I think it falls under the category of “if things get that bad, we’ll have bigger things to worry about“.

But I do wonder if that’s overly optimistic. I guess it comes down to: in what (or in whom) can you trust?

Joe Isuzu

Anyone remember these ads?

But enough about me. Do you believe that the Roth rules will change in your lifetime?

Mike Pumphrey

Mike Pumphrey

I'm the founder and author of Unlikely Radical, a site to help people succeed with money, achieve their goals, and live intentionally.

I offer a free phone consultation to anyone who is interested in changing their financial narrative. Are you ready? Click here for details.
Mike Pumphrey
Posted on April 13, 2017