Saturday, January 9, 2016

How Future Expected Long-term Care Expenses Affect Your Current Retirement Spending Budget

Like all other future expenses a retiree expects to fund with her accumulated retirement savings,  a retiree (with possible help from her financial advisor) should plan on the possibility of incurring costs associated with long-term care.   Under the actuarial approach advocated in this website, this is accomplished by including the present value of future expected long-term care expenses in a retiree's liabilities (and the present value of any long-term care insurance as an asset) when matching the retiree's assets and liabilities.  In our post of December 21, 2015, we indicated that for someone currently living in California, that present value might be in the neighborhood of $200,000, based on an assumption of three year's stay at an assisted living facility, one year's stay at a nursing home facility and future increases in estimated current costs (which clearly will vary from facility to facility) of 4.5% per annum.  This is only a rough ballpark estimate, and I encourage you or your financial advisor to investigate costs in your area and make your own reasonable assumptions.  However, if you do set up a reserve for future long-term care expenses, you should understand that this money will not also be available for you to "tap" for other expenses. 

The "Excluding Social Security V 3.1" spreadsheet in this website can be used to estimate a current appropriate reserve (present value) for long-term care expenses by increasing current estimated long-term care costs with expected future increases in such costs, entering that amount as the desired amount of savings remaining at death (including possible reserve for long-term care), and solving for the accumulated savings that will leave that amount at death (with little or no withdrawals prior to the end of the input period). 
This is a trial and error process.

One of my actuary friends indicated that I punted somewhat on this issue in my post of December 26, 2015 when I had my hypothetical retiree, Richard Retiree simply assume that the equity in his home would cover his future long-term care expenses.   If Richard's home equity were significantly more or less than the estimated present value of his future long-term care cost and he plans on spending his home equity during his retirement,  he could include the current value of his home equity as an asset in the spreadsheet and the future expected cost of long-term care as a liability as discussed in the paragraph above.

Readers may be interested in several recent articles on this subject from Dr. Wade Pfau:

Some of the key takeaways from Wade's articles include:

  • Long-term care is a generally a larger need (and therefore a higher expected cost) for women than men. 
  • "The odds for needing long-term care are higher for individuals with greater longevity in their family history and those with a family medical history including dementia, Alzheimer’s disease, and neurological disorders."
  • "Costs for long-term care vary by geographic region, type of facility and services used, and reasons for care."
  • "Generally, the cost of long-term care has risen faster than overall consumer price inflation."
Bottom Line:  As Dr. Pfau points out, "Retirement planning is complicated."  It involves much more than simply withdrawing X% of your accumulated savings each year and hoping that you won't run out of money.  To do it right, you need to periodically compare your assets (your current investments plus the present value of future payments you expect to receive from various sources) with your liabilities (the present value of your future expenses).  I understand that you may not want your spending budget to change significantly from year to year (as might be the case if you strictly balanced your assets and liabilities each year), but at a minimum, you need to periodically check to see that your spending does not significantly deviate from the budget value determined using sound actuarial principles.