One of the most difficult aspects (both financial and emotional) of planning for your retirement is how to prepare for the possibility of eventually needing long term care assistance. Anyone who has gone through this with their own parents can attest to how wrenching the process can be for all involved.
An individual needing Long Term Care is generally defined as someone that needs assistance with certain “activities of daily living” (ADLs) The ADLs include (1) bathing; (2) continence; (3) dressing; (4) eating; (5) toileting and (6) transferring. Most long term care insurance policies are triggered when a doctor certifies that a policyholder needs assistance with at least two ADL’s.
The care may be provided in a number of different settings – in the home, adult day care facilities, assisted living facilities or skilled nursing facilities with costs that vary greatly.
Here are some statistics related to Long Term Care:
- 68% – The lifetime probability of becoming disabled in at least two activities of daily living or of being cognitively impaired for people age 65 and older.
- 40% – Percentage of individuals who reach age 65 who will enter a nursing home during their lifetimes.
- 20% – Percentage of individuals who reach age 65 who will enter a nursing home and stay for more than one year (average is 2.9 Years)
Source: Morningstar Article – 40 Must-Know Statistics about Long-Term Care – Christine Benz – 08/09/12
Medicare for the most part does not cover long term care expenses. The only government program that covers long term care is Medicaid which is only available to individuals who meet strict income limits and have exhausted all their assets (with certain exceptions).
Those planning for long term care expense have three options: pay out of pocket, purchase long term care insurance or a combination of the two. Let’s use the example of a 55 year old couple where it is determined that $900,000 of protection would be a reasonable target to protect against the one in five chance of needing extended care. This estimate would be based on the cost of care in their state which varies widely. An estimate for insurance premiums for a 55 year old couple looking for $900,000 of protection might be $5,000 a year (there are many options available to configure a long term care policy which I will delve into in a future blog post).
If the couple was wealthy and could afford the $900,000 cost without a major impact on their lifestyle, paying out of pocket is a viable option. On the other end of the spectrum, if the couple has very limited means and cannot afford the insurance premiums they will have to rely on Medicaid if the need arises. I will focus the rest of the discussion on those in between those extremes where the decision will not be so clear cut.
Part of the reason that long term care insurance is so expensive is that a significant number of policyholders end up filing claims against their policies. The other issue is that insurance companies are required to invest premiums in low risk bonds and the low interest rate environment has impacted their profitability forcing them to raise premiums to make up the difference.
Having said that, there is still significant leverage to be had by purchasing long term care insurance. In my example above, if instead of purchasing insurance the 55 year old couple invested the $5,000 per year premium in a tax deferred IRA and earned a 6% return, by age 80 they would have a fund equaling $200,000 (after tax) to use for long term care expenses. This is far less than the $900,000 in insurance benefits. If either spouse were to require extended long term care they will be forced to begin to depleting their retirement fund. On the other hand, there might be only a 20% chance that extended care would be required. The other 80% of the time the fund they have set aside would likely cover a good portion of the cost.
I have suggested another approach to several of my clients to balance these risks that uses a combination of paying out of pocket and purchasing insurance. It has been well received. If the couple above were to purchase a policy with $450,000 of combined benefit instead of $900,000 the annual premiums would drop by 50%-60%. They could then designate a portion of their retirement portfolio as the “Long Term Care” fund and exclude it from their pool of funds planned for use for their normal living expenses during retirement. In our example, let’s assume that is $150,000. If the fund earns a 6% return it would grow to $450,000 (after tax) by age 80 and combined with the $450,000 of insurance would provide the $900,000 of protection. If extended long term care is not required the insurance would be used to cover lesser amounts and the $450,000 in the “Long Term Care” fund could be passed on to the heirs of their estate.
From a pure math perspective, the best time to purchase long term care insurance is when you are in your mid-fifties (based on the way these policies are priced today). If you were to purchase long term care insurance at a younger age (let’s say in your mid-forties) the premiums would be lower but you will be paying those premiums for a greater number of years, making the overall cost higher. However as you near age 60, the cost of the premiums begin to escalate so much that even though you are paying premiums for a fewer number of years, the overall cost is higher. Mid fifties is the sweet spot. That does not mean that you should not purchase long term care if you are in your sixties. It is just that you will want to move on this sooner rather than later since the overall cost will go up with each passing year.
I do think it makes sense to work with an independent, fee-only advisor to help determine what the right strategy is for you. If you work directly with an insurance agent (or with an advisor who collects a commission based on the sale of insurance) realize they are incented to sell insurance and may not think to suggest a more balanced approach.