The Importance of Planning for Long-Term Care

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Most of the research about retirement income planning focuses on two of the three major retirement risks: sequence of return risk and longevity risk. The third one, the risk of severe spikes in spending due to unforeseen expenses, receives much less coverage. Being able to meet a predetermined spending plan alone is not sufficient. There must also be mechanisms in place to deal with the various contingencies that may arise during a long retirement.

Long-term care (LTC) spending represents one of the most severe spending shocks that can impact retirees. Long-term care is a general category for care related to physical, mental, social, and medical needs in the event of significant physical or mental declines. The potential for such decline accelerates with age.

Common statistics about how most people will need long-term care, such as the oft-cited number at longtermcare.gov that at least 70% of people aged 65 and older will need some form of long-term care services during their lifetimes, generally include shorter-term events in their calculations as well.

Long-term care expenses are uncertain, ranging from $0 to potentially over $1 million. An expensive LTC event could derail an otherwise well-built retirement plan. This problem is growing as people are living longer since it becomes more likely that care will be needed for longer as well. Older individuals suffer from higher rates of physical and cognitive problems, and they may have fewer family members or friends who are in a position to provide sustained daily assistance.

Because costs are high, and the probabilities are not particularly low, most long-term care funding strategies will add significant expenses to a retirement plan, either in the form of insurance premiums or as investments that are set aside as reserves and not available for the rest of the population. Planning for how to manage these potential expenses is an important part of a retirement income plan. However, it is often overlooked. Many are unwilling to confront the questions and possibilities related to losing their own independence.

Psychologically, it can be difficult to face morbidity as no one likes thinking about the possibility they will no longer be able to effectively handle all of the basic activities of daily living. You might think this is something that only happens to other people, which is a natural response.

A common misperception also remains that Medicare pays for long-term care. It doesn’t. Few people make proper plans for long-term care. This lack of planning can create strains as long-term care depletes household assets, bankrupts a surviving spouse, or adds burdens for other family members who may end up making large sacrifices to provide care.

The default long-term care plan will be to self-fund any expenses until assets are depleted and then transition into Medicaid. But there are other possibilities: No retirement income plan is complete without proper consideration of how to integrate funding for potential long-term care needs.

A holistic retirement income plan should integrate strategies for funding potential long-term care needs. Whether through insurance, earmarked investments, or alternative financial tools, addressing the risk of severe spending shocks due to long-term care is essential for safeguarding the overall success and sustainability of one's retirement plan.

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Wade Pfau, Ph.D., CFA, RICP®