The one thing that can blow up your retirement plan

Last week, Mass Mutual announced a plan to raise long-term care insurance premiums by 77 percent for most of its existing customers1. The announcement illustrates a fundamental problem for most seniors today: how to pay for long-term care. The most important question to ask when thinking about long-term care — no matter how somber — is how will you die? Peacefully, you hope. Natural causes would be nice. Unfortunately, none of us have a choice. About half of Americans over age 65 will need long-term care services at some point, and one in seven adults will have a disability that lasts more than five years. We aren’t comfortable discussing our mortality because our brains are terrible at imagining the future.

Increasing care costs, limited federal assistance, and the rise of nursing homes have changed the way we age in society. The process has become so unappealing that many clients tell me they don’t want to live into their 90s. Author and public health researcher Dr. Atul Gawande writes at length about the plight facing aging Americans today in his book Being Mortal. Gawande describes the many motivated pioneers pushing for positive changes to the aging process in America, but the problem of how to pay for it all still exists.

The alternative is a cultural shift in the way Americans face aging. In Gawande’s home country of India, it is not uncommon to find four generations in a single household. That scene is a rarity in America, where nursing homes and other forms of assisted living have become the dominant trend. Assuming this cultural shift is not on the near-term horizon, we have to address how to pay for the costs of long-term care when building retirement plans.

Most retirees rely on Medicare to cover medical costs in retirement, but the scope of long-term care services that Medicare will pay for is limited in both nature and duration. Custodial care (such as a nursing home) is not covered, and skilled nursing care is limited to 100 days and notably excludes benefits for people with dementia or Alzheimer’s disease. The other arm of federal assistance, Medicaid, is only available to people that have less than a few thousand dollars in assets, depending on the state. So, if you have any amount of money and need care beyond what Medicare provides, (which is basically nothing) it only leaves two options, self-funding or additional insurance.

The cost of long-term care has been rising dramatically, so self-funding the costs has become prohibitive for the vast majority of Americans. The average annual cost for a private room in a nursing home is a little over $92,000 per year2. How long can your nest egg support withdrawals at that level? For most retirees the answer is maybe a few years, but life expectancy for a person with Alzheimer’s disease is 8 to 12 years. That means the cost of long-term care for one person could exceed $1 million dollars, which is substantial even for millionaires. Social Security on its own is not enough to cover the cost, even if both spouses attain the maximum benefit. If and when your assets are depleted, Medicaid will become available as a last resort, but this is not ideal because your options will be limited to state-run facilities that accept Medicaid. And, you won’t be able to leave a legacy to your heirs. Sometimes children will spend their own money to support a parent in long-term care, which then puts them at a disadvantage to retire comfortably.

Clients tell me all the time that they don’t want to be a burden to their family members if they require long-term care. Many have experienced a parent without the necessary resources to cover care costs. They wished for better care for their parent, but didn’t have the ability to provide it. Because self-funding is so costly, insurance is the primary alternative available to protect against this risk and reduce the burden on family members.

There are a several insurance options available, all with pros and cons. You will want to talk to your insurance agent to figure out which, if any, is best for you.

• Traditional Long-term Care Insurance – These policies will pay a stated benefit amount over a defined period of time if you are chronically ill. Usually this means being unable to perform two of the six activities of daily living (ADL’s), which are eating, bathing, dressing, transferring from bed to chair, using the toilet, and maintaining continence. When companies initially started providing this type of insurance, they significantly underestimated the cost of the claims they would have to pay. Because of this, not only did many insurance companies leave the market, the cost of long-term care insurance premiums spiked to recover the costs of the insurers (i.e. Mass Mutual). Another issue people have with traditional LTC policies is that you never receive any benefit if you don’t need the care. The next option addresses this shortfall.

• Life Insurance/Long-term Care Hybrid Insurance – Some insurance companies have gotten creative and are now offering policies that combine life insurance with long-term care coverage. At policy inception, the policy contains a tax-free death benefit just like a traditional life insurance policy. If you need to access the policy for long-term care, the amount you withdraw from the policy reduces the death benefit by the same amount. If you don’t use the long-term care component, the full death benefit will be paid to the beneficiary at death.

• Accelerated Death Benefit Riders – Some life insurance policies have the option to add a rider that allows the insured to access part of the death benefit early if they become chronically or terminally ill. There may be specific requirements, such as a maximum remaining life expectancy, to trigger the benefit to be paid. The accelerated benefit is fully excludable from income and reduces the amount of the death benefit that will be paid to the beneficiary.

Long-term care insurance options and self-funding will both cost you a significant amount of money. Unfortunately, there is no way around it unless we see legislative intervention or a cultural shift in how Americans age. The trade-off exists between using existing assets now to purchase insurance or depleting assets later, potentially leaving your heirs with less. It should be noted that money is fungible, so if it is not spent on insurance, it can continue to grow in your investment portfolio and potentially cover self-funding costs. Whether or not the gamble will pay off depends on market conditions and whether you’ll need long-term care.

Our complicated brains do not often allow us to think about our own demise, but it’s critically important to address long-term care risk before you get sick. Like health and life insurance, the cost

of insurance options increases as you get older. This cost should be considered alongside your family health history to determine which option is best to address long-term care risk. Aging can be formidable, but it doesn’t have to be stressful if you plan ahead. Take the appropriate steps now and your family will thank you later.