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: investment, or sequence, risk, and longevity risk. The question to be answered is how well does a predetermined spending plan work in the face of market volatility and unknown longevity?

The third major risk, which receives less coverage, is the category of spending shocks or having to spend amounts significantly higher than planned. 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.

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 that this is something that only happens to other people, and that 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.

Defining Long-Term Care

Long-term care is generally defined as requiring assistance with normal activities of daily living (ADLs) for more than 100 days. Any event lasting less than 100 days is not considered to be a long-term care need and would also have a smaller financial impact on the household.

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

More specifically, a long-term care need is defined as requiring help with two or more of six common ADLs: bathing, continence, dressing, eating, toileting, and transferring – such as to or from a bed. Difficulties with dressing and bathing generally develop first.

Defining exactly when long-term care is needed can become a rather technical issue, and it is generally determined by a physician. Commonly, a long-term care need is determined when you experience chronic difficulties with performing at least two ADLs in order to avoid causing harm to yourself or others.

Cognitive impairments such as dementia may also serve as an indicator of a long-term care need, even if the impairment does not immediately lead to an inability to perform ADLs. Triggers for requiring long-term care can relate to both physical and mental decline.

Higher-order activities that may require assistance without necessarily qualifying for long-term care benefits include managing household finances, driving, and house cleaning. This assistance would more commonly be provided by family and friends rather than formally hired caregivers. These are called incidental activities for daily living (IADLs).

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Wade Pfau, Ph.D., CFA, RICP®