Personal Finance

How to Evaluate Long-Term Care Needs

By Bob Dockendorff, JD, LLM

Long-term care may seem grim, but it is a necessary topic for older Americans. It’s easy to understand why you'd want to ignore this issue. It's unpleasant, expensive and there are very rarely easy ways to fund the expense. But the issue isn’t going away, and the earlier folks consider the problem, the sooner they’ll find a viable solution.

For purposes of retirement planning, the most productive way to think about long-term care and ways to fund your care is to consider any long-term-care (LTC) insurance policy as the pre-funding of a future expense. Unlike other insurance, that requires a small premium to cover a catastrophic but unlikely contingency, long-term care is statistically probable for most people. (For related reading, see: Long-Term Care: How and Why You Should Plan for It.)

Questions to Ask

Recognizing the need and planning for the expense are two very different things. In order to plan for long-term care, you'll need to answer these questions: Why type of care will I need? When and how long will I need it? How much will it cost?

Although there are no clear answers to these questions, you can develop assumptions based on available information and use those in retirement plans. One good place to start, for everyone, is the macro data on long-term care needs and cost:

  • It’s estimated that about 70% of individuals over 65 will need at least some form of long-term care at some point in their lives.
  • The average cost of a nursing home in the United States is $97,500 per year and has grown annually at about 3%.
  • The average stay in a nursing home is about three years.
  • The average age of individuals entering a nursing home is 81.

The Cost of Long-Term Care

Based on the numbers, people should assume they will need about three years of long term-care in their 80s. That is a total long-term care need of about $300,000 per person, in today’s dollars. For a 65-year-old we can assume 15 years of growth and the number becomes $442,000 of needed long-term care coverage, adjusted for inflation. Also note that folks should adjust these numbers for their geographic location. The current annual cost of a nursing home private room in Ohio is $96,000, but is significantly higher in states like Massachusetts where the cost is $150,000. Make sure you’re insuring for the state where you’ll receive care. (For more, see: Medicaid vs. Long-Term Care Insurance.)

What happens to your retirement expense if you have to add an additional $442,000 over three years and you are in your early 80s? For those that can’t fathom such an expense, you should consider Medicaid planning. For those who think they may need more help covering these expenses, do the following to determine your “cost of care” number:

1. Determine the annual cost of a private nursing home in your state.

2. Multiply it by three for the average number of years individuals need care.

3. Subtract your current age from 80.

4. Grow number two above by 3% inflation compounded annually for the number of years until age 80.

If you’re 55 and live in Massachusetts, the calculation would be as follows:

1. Average annual cost of a private room in a nursing home is $150,000.

2. $150,000 x 3 = $450,000

3. 80-55 = 25 years

4. $450,000*(1+2%)^25 = $738,273

Now take your “cost of care” number and run a retirement projection to see how it affects your chances of retirement success. If a long-term care event brings your chances of success to a level you’re not comfortable with, say 65%, then do the following:

  • Obtain a quote for sufficient long-term care insurance.
  • Add the premium to your retirement expense plan.
  • Run the plan with insurance and then both with and without a long-term care event.

If you can’t pay for enough coverage without derailing your retirement plan, then consider Medicaid planning. But for those that can afford the premium and significantly reduce the impact of a long-term care event, strongly consider purchasing private long-term care insurance.

An Example

Here’s an example for our 55-year-olds above. The percentages refer to the chance that our retiree has of not outliving their money based on 1,000 random investment return scenarios.

You can see that under the base plan (no LTC, no Insurance) they have 100% chance of success. With LTC needs, but no coverage, they only survive 35% of the time. These are the extremes. But if we add in the cost of long-term care they have at least a 75% chance of not outliving their money. And if they buy the premiums but never need the insurance, they still have a 98% chance. In this instance I would heavily recommend purchasing the coverage.

Considerations for the Wealthy

What about the folks that can afford long term costs? This includes retirees with several million dollars that can absorb long-term care costs without risking their chances of a successful retirement. In this case it becomes more about optimizing to save on potential long-term care costs through asset repositioning and the use of a hybrid insurance policy.

Imagine you’re 55-years-old and plan to have $3 million when you retire at age 67 - more than enough to sustain living and potential long-term care expenses. One third, about $1 million, of your portfolio will have exposure to low-volatility cash and fixed-income investments. What if you could take $100,000 of those assets (3.3% of all assets) and “park” them in a whole life insurance policy that offers a death benefit, cash value and $250,000 of long term-care benefit growing at a compounding 3%.

You can also start “parking” that $100,000 over 10 years prior to retirement at an equal $10,000 per year. From a linear cash flow stand point this strategy would help absorb the cost of long-term care without risking the principal and keeping foregone investment returns at a minimum as those funds were ear marked for low return assets anyway. Looking at the projected costs of long-term care, foregone investment growth and hybrid premiums, the following chart shows the ultimate cost of all scenarios.

Using the same chart above we can see the cost of each scenario. I kept it in today’s dollars, which doesn’t account for growth or inflation. The cost of having, and not needing, a hybrid insurance policy is low because there is a cash value and repayment of premium. For those with significant assets, this cost is negligible.

The benefit, however, is significant as the cost savings in the (more likely than not) long-term care event is $194,00 ($364k - $170k). This looks more like traditional insurance. The asset repositioning strategy is attractive for high-net-worth individuals.

Conclusion

Without having any perfect way to plan for long-term care, this framework provides at least a reference point to conduct analysis for purchasing LTC insurance. Each individual should speak with their financial planner and insurance professional to tweak assumptions for any specific available facts. Overall, I think by using statistics and best/worst case scenarios we seek to achieve the highest likelihood for a comfortable, stable and predictable retirement. (For more, see: Medicaid vs. Long-Term Care Insurance.)\

This article was originally published on Investopedia.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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