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Paying for Aging

John Lim

HERE’S A SOBERING statistic: It’s estimated that 50% to 60% of 65-year-olds will require long-term care at some point in their lives. This is defined as assistance with activities of daily living—things like taking a bath, dressing oneself, and maintaining bowel and bladder continence. How’s that for something to look forward to?

Such care isn’t cheap. By some estimates, the average 65-year-old can expect to incur $138,000 in long-term-care (LTC) expenses, with half of that cost borne by families. Mind you, this is just the average, which includes those who will never need long-term care. For those who do shell out, the average lifetime cost is closer to $266,000.

Long-term care is a classic example of what retirement expert Wade Pfau has referred to as a spending shock. If you don’t account for such spending shocks, they could easily derail an otherwise well-planned retirement.

Without delving into too much detail, the following are the primary ways retirees deal with LTC expenses:

  • Self-funding followed by Medicaid. Once personal assets are spent, Medicaid picks up the expense. This is the default option and also the most common approach in the U.S.
  • Traditional long-term-care insurance. Unsurprisingly, LTC insurance is expensive. Policies are not standardized and can be quite complicated. While the history of LTC insurance is blighted, this is clearly one option.
  • Hybrid policies. These life insurance or tax-deferred annuity policies include the ability to withdraw funds for LTC expenses. This is another option—but a complex one. You’ll need to read the fine print carefully.

I propose a fourth option, which is far simpler than the second and third options above. It also addresses another major risk—perhaps the risk—in retirement, namely longevity risk.

My proposal centers on deferred income annuities (DIAs), also known as longevity insurance or—if purchased with retirement account money—as a qualified longevity annuity contract. I believe DIAs could play a significant role in addressing the risk of long-term care in retirement.

Don’t let the names fool you. This is just a bread-and-butter income annuity with one quirk: The annuity doesn’t pay out immediately, but only after a delay. For example, you could buy a DIA at age 50. In exchange for a onetime lump-sum payment, you’d receive an income stream for life. That income stream wouldn’t begin until, say, age 75.

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Why would this make sense for long-term care? The risk of needing care rises in lockstep with age. The incidence of Alzheimer’s disease, for example, begins to skyrocket after age 80. When you are most likely to require care, a DIA could be there to help pay for it.

Longevity risk is the possibility that a very long retirement depletes our financial resources. Put simply, it’s the risk of running out of money before we run out of breath. The longer we live, the greater the risk that this will happen.

A spending shock late in retirement—such as one member of a married couple requiring nursing home care—could exacerbate longevity risk for the surviving spouse. A DIA could not only help defray the cost of long-term care, but also provide an income floor should the couple’s savings become depleted.

Because the annuity’s payout is deferred until age 75, mortality credits—the secret sauce of annuities—are maximized. Put bluntly, those who die before 75 don’t receive a cent, which leaves far more generous payouts for those who live longer than 75. These “survivors” are precisely the ones who face the greatest financial risks from long-term care and longevity.

Still, you may ask: What if I need long-term care before I reach 75? In this scenario, your portfolio would indeed be called upon to fund long-term-care costs without the help of the DIA—at least until 75. But such a spending shock could more easily be absorbed by the larger portfolio available earlier in retirement. The stress on those assets would then be relieved at 75 by the annuity’s payout, providing the beneficiary reaches that age.

Another reason to consider this approach: If you have a health issue that precludes you from qualifying for LTC insurance, or makes such insurance prohibitively expensive, a DIA requires no such underwriting.

Some other advantages of DIAs: They are far simpler to understand than long-term-care insurance or hybrid policies. Remember, also, that slightly less than half of the population won’t require any long-term care. If you’re in that lucky pool, a DIA is not money wasted. It will help fund your retirement late into your golden years, while reducing the worry of depleting your portfolio. The added income from the annuity could also help with rising costs late in life, during what is called the “spending smile.”

For those of greater means, Medicaid is less likely to play a role in paying for long-term care. This well-to-do cohort is also best positioned to afford a DIA to partially fund retirement in the first place.

Finally, while Medicaid is always the default option, the quality of care it provides may be less than desirable. It is a welfare program, after all.

John Lim is a physician and author of “How to Raise Your Child’s Financial IQ,” which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles.

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Bob Wilmes
Bob Wilmes
7 months ago

Does anyone know how LTC insurance is treated by the continuing care retirement (CCR) communities? my wife and I have very old LTC insurance but are interested on the impact of CCR communities.

Jonathan Clements
Admin
Jonathan Clements
7 months ago
Reply to  Bob Wilmes

It should result in a lower monthly fee at the CCRC:

https://humbledollar.com/2022/03/life-care-compared/

BenefitJack
BenefitJack
8 months ago

If you are saving for future medical expenses, including expenses in retirement, deciding what product/financial instrument to use depends on your access to tax preferred plans/programs and perhaps your age. However, regardless of your age, if you are still working, you should seek out employers who offer Health Savings Account – capable health coverage. Or, if you like your current employer, ask them to offer that coverage option – it offers great value to both the employer and the employees. The HSA should be part of your arsenal – in addition to your 401k, 403b, IRA, etc.

A small number of Americans incur significant annual medical expense – and most of them are old or disabled or have chronic diseases or all three. For comparison, a significant majority of Americans incur less than $500 a year in out of pocket medical expenses (assuming your health plan 100% for preventive services as required/permitted under Health Reform). According to the Kaiser Family Foundation, “… the population with spending below or equal to the 50th percentile accounted for 2% of all out-of-pocket spending. … People who are in the bottom 50% of out-of-pocket spending spent an average of $28 out-of-pocket.” Yes, half of all Americans spend $28 or less out of pocket in any one year. The last year of data they used in their study was 2019. See: https://www.healthsystemtracker.org/chart-collection/health-expenditures-vary-across-population/

So, if you are saving for a retirement in the 2nd half of the 21st Century, if you have 30+ years to prepare, and if you have health status typical for Americans, you can use the HSA on much the same basis as a 401(k) or 403(b) and diligent savers and investors can accumulate hundreds of thousands of dollars in HSA assets. Don’t forget that saving in a HSA offers better tax preferences than a 401(k) or 403(b), and that the HSAs assets are not limited to medical expenses – they can do quadruple duty: (1) Current and future year out of pocket expenses, (including long term care insurance premium or out of pocket costs), (2) retiree medical and long term care out of pocket costs and insurance premiums, including Medicare B and D and LTC premiums, a penalty tax free income after age 65 and a survivor benefit.

Always available to discuss.

See: https://www.soa.org/globalassets/assets/library/newsletters/retirement-section-news/2020/august/rsn-2020-08-towarnicky.pdf

R T
R T
8 months ago

Thank you so much for this detailed and practical discussion – The article and all of the comments are so helpful! Also, “My Experiments” by James McGlynn (Mar 5 2022) is a nice connect in with this article.

I’ve been researching LTC insurance in some combination with life insurance but between this article and “My Experiments”, you’re making me feel that annuities would be even better. An LI/LTC approach would be be limited in utility to care or death coverage. The annuity approach would give a safety net for late-life income even if we don’t need long-term care.

What age would you target for purchase of annuities for someone approaching retirement?

Or is there some other milestone besides “purchase age” that you would use as a trigger to purchase?

What are your thoughts about annuities for someone in their 20s/30s deferred to age 80 or so?

Mark Schwartz
Mark Schwartz
8 months ago

My LTC plan included buying 5 rental houses for 30 cents on the dollar in 2010 when foreclosures were rampant. The houses I bought at that time were investments in my retirement future as well as a plan to self fund any LTC needs. Three were purchased within my IRA and two were purchased outside the IRA. Each house was upgraded a bit with fresh paint, carpet and some tile and have been rented now for 12 years. The market has increased the value of these houses in several cases over 600% plus I’ve collected rent each month along the way. I’m self funding my own long term care with the value of these properties. I’ll sell them when the time comes as needed.

Peter Blanchette
Peter Blanchette
8 months ago

It sounds as if you have never heard of state LTC partnership policies(available in all except for about a couple states…Alaska,Hawaii, Misssissippi).

“Long Term Care (LTC) Partnership Programs are a collaboration between private long-term care insurance companies and a state’s Medicaid program. The intention of partnership programs is to encourage the purchase of long term care insurance to help cover the costs of long term care, while also alleviating the burden on the states to pay for this type of care via Medicaid. Of particular relevance to seniors who may need long term care Medicaid in the future, participating in a partnership program protects some (or in some cases, all) of a program participant’s assets (resources) from Medicaid’s asset limit. Furthermore, the “protected” assets are also safe from Medicaid’s asset recovery program, sheltering assets as inheritance for family after the passing of a Medicaid recipient. (This will be covered in more detail below). Partnership for Long Term Care Programs can be thought of as a Medicaid asset protection technique for healthy seniors who do not have an immediate need for long term care.”

I have one of these policies with a 90 elimination period with 5% daily rate yearly inflation adjustment. Bought it about 15 years ago and the policy premium has increased pretty much with a 3% inflation rate. It does not increase on a strictly year by year basis but in random increments which can be shocking. But overall the cost of the premium has increased about 3% per year. Of course you should pick a highly rated insurer.

Sabine Nooteboom
Sabine Nooteboom
8 months ago

We bought California Partnership LTC policies in 2010. We selected the 10-year payment option for these policies, which are shared care (six years of benefits total that either of us can access) with a 5% compounded annual inflation rider. They were probably a wise purchase, offering piece of mind even if we never use them. However, the Partnership feature will no longer be a worthwhile benefit as California will soon be eliminating any asset requirements for qualifying for Medicaid (called Medi Cal in California) – https://cahealthadvocates.org/medi-cals-asset-test-to-be-eliminated-by-july-1-2022/

Jonathan Clements
Admin
Jonathan Clements
8 months ago

Thanks for the link — but the author keeps referring to Medicare, not Medicaid, so I hope she has her facts correct!

R Quinn
R Quinn
8 months ago

Most LTC is provided by family caregivers, even less institutionalized. I purchased LTC insurance when I was 45 33 years ago. Now they are raising premiums to try and get policies cancelled. 2020 46% and 2021 25% Insurers miscalculated the costs.

Luckless Pedestrian
Luckless Pedestrian
8 months ago

Good article. I bought a QLAC last year at age 66 that will start paying out at age 76. One benefit that you didn’t mention is that the dollar value of one’s IRA is decreased by the amount used to purchase the QLAC (in my case, $135,000), which has the effect of reducing taxes on RMDs at age 72 and beyond.

mytimetotravel
mytimetotravel
8 months ago

I have the same problem with these annuities I have with simple immediate annuities – no inflation protection. I have a pension with no COLA, I certainly don’t want another product with the same problem. Those who didn’t experience inflation in the 70s as I did may not fully appreciate the significant loss of purchasing power that inflation can cause, although we are currently getting a taste of it. I am certainly glad I did not buy an annuity a couple of years ago. (If anyone knows of an annuity I can buy that does have a COLA, I am all ears.)

I am dealing with the LTC issue by moving to a non-profit CCRC with sound finances, assisted living and skilled nursing facilities, that promises not to throw me out if I run out of money. And if I get a diagnosis that will consign me to skilled nursing or “memory care” for the rest of my life, I aim to take a one-way trip to Switzerland and Dignitas.

parkslope
parkslope
8 months ago
Reply to  mytimetotravel

A series of DIAs can provide you with inflation protection, although you would have to use an estimated inflation rate. Your money has to go somewhere and this approach is likely to pay better than other conservative investments.

My 99-year-old mother opted for a LifeCare retirement residence 15 years ago because she wanted to make sure that her children would never need to provide her with financial assistance. It has been a source of pride for her even though she knows that we could easily afford to support her.

Jackie
Jackie
8 months ago
Reply to  mytimetotravel

Its a shame you will have to travel to Switzerland to maintain control of your body. Laws that bar assisted suicide significantly limit our personal freedom. I wish the government would butt out of this decision.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
8 months ago

When I bought my QLAC (DIA from IRA) the motivator was to pay for LTC expenses. The thing about DIA’s is that those in poor health should not buy them since they probably won’t live long enough to benefit. But after I researched hybid policies I found them much more applicable. For those who are not in great health they might qualify for hybrid annuities that provide an extra pool of money if used for LTC expenses. They are received tax-free for that purpose. If someone has major gains in an old annuity they can exchange them for an LTC annuity and if the benfit is paid as an LTC expense never have to pay taxes on the gains. Yes hybrid policies are more involved than a DIA but provide better benefits.That is why I added a hybrid LTC policy after I purchased my QLAC.

Ormode
Ormode
8 months ago

First, you have to have a realistic assessment of risk. The percentage of retirees who need care for more than 90 days is less than 25%. Could you pay $400 a day for 90 days? Many people can.
So you have to look at your total financial picture and see how much you could pay with the income and assets you have. Retirees in the top 25% of income and assets can pay a lot. If you worked all your life in a high-paid profession, and saved a lot of money, this is not a problem you should have.

Jackie
Jackie
8 months ago
Reply to  Ormode

Also, Medicare may pay for up to 90 days after a hospitalization.

R Quinn
R Quinn
8 months ago
Reply to  Jackie

Only if it’s for rehabilitation , not true LTC

Sabine Nooteboom
Sabine Nooteboom
8 months ago
Reply to  R Quinn
Mik Cajon
Mik Cajon
8 months ago

The same level/quality of employees working at private LTC facilities are also employed at the less desirable facilities…more money does not equal better care, but rather nicer surroundings…home health care is probably a better option.

Last edited 8 months ago by Mik Cajon
Nate Allen
Nate Allen
8 months ago
Reply to  Mik Cajon

Presumably they would be able to attract a higher level of talent if they pay higher wages, no?

Jackie
Jackie
8 months ago
Reply to  Nate Allen

No. They pay market rates, not more. Having both worked at a LTC facility and had relatives at at LTC facilities, I can attest the care is not better at the fancier places, just nicer surroundings as Mik mentioned. At the facility that my MIL stayed at, they had tons of amenities, but the staff resented servicing the very well off while they struggled with wages that weren’t enough to live on. It definitely showed in the care. Eventually we took my MIL out of there and hired live-in help. She had better care at a lower cost.

David Lamb
David Lamb
8 months ago
Reply to  Mik Cajon

Agreed. Many people seem to hold a non-fact based stereotype against facilities that accept Medicare.

OldITGuy
OldITGuy
8 months ago

Good article. I really liked the point that a DIA is an option for someone who can’t qualify for a LTC policy. That’s a use I hadn’t previously considered. Thanks.

Bob
Bob
8 months ago

Agree.

I have a traditional LTC policy. I’ve often wondered why insurers don’t offer a variety of waiting periods before coverage begins. I’m pretty sure I could cover a couple of years of LTC expenses, but I probably couldn’t cover 10 years. I’d gladly buy a policy that didn’t begin paying for a couple of years. Premium should be lower, because of exactly the same dynamics that apply to deferred fixed annuities. A high percentage of people who start to need LTC will die within a couple of years.

Jonathan Clements
Admin
Jonathan Clements
8 months ago
Reply to  Bob

Years ago, I was told by a senior executive at New York Life that the insurer would love to offer an LTC policy with a multi-year wait (or elimination) period between qualifying for benefits and those benefits being paid, but that state insurance commissioners wouldn’t allow it, presumably because policyholders would complain that they’d somehow been tricked into buying such policies.

Sabine Nooteboom
Sabine Nooteboom
8 months ago

I disagree. I prefer “short fat” policies (high daily maximums for a short number of years) with the 90 day elimination period. The reason is that it’s very unlikely that you’ll need LTC at the SNF level for longer than three years, especially if the LTC begins late in life. Always use begin using your LTC benefits as soon as you qualify; you may start out needing help with a couple of ADLs for just a few hours per day. If you were able to purchase a LTC with a very long elimination period the chances are great that you would never use it, and after three years living in a SNF as a private patient going on to Medicaid LTC may be a viable option, especially in states such as California that have relatively good protections for nursing home residents (e.g., you can’t be moved from a facility just because you transition from private pay to Medi-Cal LTSS, California’s version of Medicaid for long-term support and services).

Ormode
Ormode
8 months ago

I would think that if these policies required proof of at least $1 million in financial assets, you would be treated as a sophisticated buyer who knew what they were getting into.

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