Retirement-Planning Advice You May Be Missing
Why future health care costs must be part of the equation
(This article previously appeared on MarketWatch.com.)
In some respects, longevity is a roll of the dice. How long will you live? Will your money — and your health — last?
So it’s fitting that the computer number-crunching model that many financial planners use to run portfolio projections is named after a gambling mecca, Monte Carlo.
Monte Carlo projections serve a useful purpose, but they have limitations when it comes to planning for the uncertainties of future medical costs in retirement — especially the wild card of long-term care costs, which can range anywhere from nothing to hundreds of thousands of dollars.
Monte Carlo, which indeed takes its name from gambling, is not a brand name but a general term used to refer to widely used programs that a variety of companies produce. What many of those programs have in common is that they assume spending will rise at a predictable rate — and with health-care expenses, unfortunately, that’s seldom the case.
While programs exist that project long-term care expenses and test their effect on a portfolio, plenty of financial advisers aren’t using them. In fact, many advisers aren’t even talking about future health-care needs with their clients. Of pre-retirees age 50-plus who work with a financial adviser, only 21 percent have had an in-depth discussion with their advisers about health-care options and costs in retirement, according to Merrill Lynch and Age Wave.
The financial planning industry generally subscribes to the rule of thumb that a retiree needs between 75 percent to 85 percent of his pre-retirement income to live comfortably. A typical Monte Carlo simulation will take that target income-replacement ratio, pair it with expected expenses, and run scenarios on different market returns to test the probability that the nest egg will last until the client reaches a given age.
Yet many retirees’ spending won’t rise on the gradual, predictable slope assumed by many computer simulations. These tests take all known expenses, such as housing, utilities, food and entertainment, and then project that spending on them will rise consistently each year at the rate of inflation — say 3 percent or 4 percent a year.
“That’s just not real life,” said Elvin Turner, research director at the Retirement Income Industry Association, a membership group of financial companies and individual financial advisers.
Indeed, long-term care needs inject a new, unanticipated expense into the equation, an expense that can rise higher than inflation each year. The median national cost of a private nursing home room nationally is $87,600 a year, in today’s dollars, according to Genworth, and in some parts of the country it’s already much higher.
While a nursing-home bill might not devastate the retirement budget of a single or widowed person who sells her home to fund the care, it’s often the case that one spouse needs custodial care while the other continues living at home, incurring the expenses of housing, food, utilities and other costs in addition to the other spouse’s nursing home bill. And if a single person or widowed person ends up needing care for years, long-term care costs could still devour their nest egg.
Monte Carlo simulations deal in probabilities —i .e., what’s the likelihood of the nest egg lasting? Often, that probability is expressed in percentage terms. For example, the simulation might say a client has an 80 percent chance of not outliving her money if she lives until age 95, given certain underlying calculations on how stocks and bonds will perform during that time. (Ironically, Monte Carlo simulations assume that market returns are unpredictable — and run multiple random scenarios to test them — but many assume that an investor’s expenses are fixed.)
But thinking of long-term care costs in terms of probabilities can leave you vulnerable, said Bob Curtis, CEO and founder of PIEtech, the Powhatan, Va.-based maker of MoneyGuidePro, a financial-planning program that includes a model for long-term care expenses. The probability that a person will need custodial care for many years is relatively low: According to some estimates, just 5 percent of the elderly will need nursing home care for 5 years or more.
But if you or your relative is one of the 5 percent, “it can be devastating,” said Curtis — so devastating that it’s worth at least thinking about how you may deal with it. In other words, you need to plan for the possibility, even when the probability is low.
To the extent that financial advisers talk to clients about funding long-term care at all, they too often focus on the rosier scenarios, experts say.
To be sure, it’s not fun to plan for the alternative to a healthy, independent retirement. Most people would much rather think about how they’ll fund their world travel than how they’ll fund help with basic tasks of daily life.
Ameriprise has a proprietary computer program that models for future long-term care needs. The program will illustrate three scenarios and test their impact on the retiree’s nest egg: what will happen if no care is needed, if care is needed for six to 18 months, and if extended care is needed. The program also tests for what will happen if spouses each need care several years apart.
Ameriprise advisers often discuss potential long-term care expenses in the context of preparing for the unexpected, said Marcy Keckler, vice president, financial advice strategy at Ameriprise and a certified financial planner. They’ll talk about what happens if a tree falls on the roof, for example, as well as the need for possible care, so that clients don’t feel overwhelmed by talk that focuses exclusively on nursing homes.
While the numbers can be daunting, people do have options when it comes to funding long-term care expenses. Here are four of the main ones:
1. Buying a long-term care policy. This purchase will transfer some of the risk of a long-term care stay to an insurance company. These policies have gotten harder to obtain in recent years, however. Medical underwriting standards have tightened, while policies have gotten both more expensive and less comprehensive. Still, they can give people peace of mind and are still worth at least considering, experts say.
2. Relying on family. Most of the elder care provided in this country is unpaid labor provided by relatives. The Congressional Budget Office estimated the value of this informal care at approximately $234 billion in 2011, or 55 percent of the total amount spent on long-term services and support for the elderly that year.
If this is your strategy, make sure that your family knows it, Keckler said. That might sound obvious, but just 20 percent of pre-retirees have discussed with their adult children the best ways to address long-term care, according to Merrill Lynch and Age Wave.
Families planning to rely on loved ones should also remain clear-eyed about the sacrifices that such care involves — even though many family members feel, if not happy, then at least duty-bound to provide it. Family caregivers who give up jobs lose wages and Social Security benefits on those wages, along with health and other benefits. For women, the average total individual amount of lost wages due to leaving the labor force early and/or reducing hours to care for a loved one equals $142,693, according to MetLife (for men the number is lower). Caregiving also exacts a physical and emotional toll: studies have shown that caregivers report high levels of stress and depression.
3. Relying on the government. Medicare does not pay for extended stays in nursing homes or assisted living. (The program will pay for shorter nursing homes stays for rehabilitation following an illness or injury.) Medicaid pays for a baseline of care for those who have exhausted most of their assets and meet strict income limits. While Medicaid is a valuable safety net, an elderly person on it gives up some control over the type of care she receives. What’s more, the program’s eligibility criteria will likely become stricter and the coverage less comprehensive in the decades to come, experts say, as boomers put a financial strain on the system.
The Department of Veterans Affairs pays for long-term care services for eligible veterans. Veterans and their families can visit the department’s website or call 800-827-1000 for more information.
4. Self-funding. People who plan to self-fund their long-term care absorb all the risk themselves. The good news is that spending can be altered in response to life events (another factor that the typical computer model doesn’t acknowledge). For example, families coping with a new Alzheimer’s diagnosis can slash their spending and ramp up their savings in anticipation of future needs. Some financial planners like to use a guaranteed income stream, such as that provided by a basic income annuity, to make sure certain expenses are covered.
Any kind of preparation for long-term care is better than nothing, experts say. Unfortunately, many people do just that — nothing at all. “It’s sort of like earthquake preparedness in California,” said Cohen, who is based in San Mateo. “No one thinks of it until the earth is shaking.”