Before answering the question posed in the title of this post, we will once again trot out the Basic Actuarial Equation underlying personal retirement finance (and the majority of posts on this website) as background for this discussion.
Background—Basic Actuarial Balance Equation for Personal Finance
Recurring expenses are those expenses that you expect to incur every year for the rest of your life, while non-recurring expenses are not expected to be incurred every year. Some non-recurring expenses may be expected to be incurred in the next few years (near-term) and some non-recurring expenses may be expected to be incurred closer to the end of life. See our post of February 7, 2019, “If You Aren’t Separately Budgeting for Non-Recurring Expenses, You Probably Don’t Have a Robust Retirement Spending Budget” for additional discussion of why we believe it is important to separately budget for non-recurring and recurring expenses (and why we believe approaches that don’t separately budget for these expenses, like most Strategic Withdrawal Plan (SWP) approaches and Monte Carlo models that develop probabilities of achieving an annual spending goal, may be missing the mark).
The above equation tells us that what we can spend (on the right-hand side of the equation) depends on the assets we have (on the left-hand side of the equation). Also, if we subtract the present value of expected and unexpected non-recurring expenses from both sides of the equation, we see that the present value of our recurring expenses will be equal to the present value of our total assets minus the present value of our non-recurring expenses.
Long-term care expenses and bequest motives are non-recurring expenses expected to be incurred later in life. Therefore, all things being equal, the larger these non-recurring expenses are estimated to be, the smaller will be the recurring expense budget data point developed under the Actuarial Approach.
Estimating the Present Value of Home Assets, Long-Term Costs and Amounts to be Left to Heirs
When budgeting, some individuals and couples make the simplifying assumption that the value of their home (or other assets) will either be available to cover long-term care costs or any excess will simply become part of their estate. Whether this is a reasonable approach depends on the actual future value of the home assets, actual costs of long-term care, bequest motives and how conservative the individual or couple wants to be. An alternative approach is to estimate the present values of these items and enter assets as assets and spending liabilities as liabilities in our workbooks to see how your recurring expense budget might be affected. You might need to use our separate Present Value Calculator workbook for these calculations. You should use assumptions consistent with the assumptions used in the ABC for this purpose.
The present value of a future sale of your home (or other asset) or the present value of proceeds from a current or future reverse mortgage should be entered in the cell for “PV Other Sources of Income” in the Input & Results tab. This present value calculation will typically involve additional assumptions with respect to future increases in home value due to passage of time, costs of selling the house, moving and any increased tax implications. You will then need to discount expected net proceeds by the assumed discount rate to obtain a net present value.
Estimating future long-term care costs is exceedingly difficult, and will depend on many unpredictable factors, such as:
- whether you have long-term care insurance,
- how much your insurance will actually provide,
- your family support situation,
- your geographical location,
- whether you will even need such care,
- possible coordination with Medicaid,
- expected length of stay,
- costs of in-home alternatives,
- whether such care will involve just one or both of the couple, etc.
As discussed in the recommended assumptions section of the Overview tab and our post of January 12, 2016, if you do not have long-term care insurance, we recommend determining the present value of expected long-term care costs as 60% of the present value of two years of assisted living and one year of nursing facility care payable at assumed lifetime planning period (LPP) minus 3 years for a single retiree or at “LPP Either Alive” minus 3 years for a married couple. This calculation will involve estimating current costs for a facility you might choose, making an assumption for future increases in these current costs due to passage of time and discounting the resulting future value using the assumed discount rate to obtain a present value. As discussed in our post of January 12, 2016, we recommend multiplying this present value by 60%, which is an estimate of the net cost resulting from offsetting the full cost by the expected reduction in recurring expenses no longer expected during the period of residence in assisted living or nursing care. This amount should be entered in the “PV Long-Term Care Costs” cell in the workbook.
Note that our recommended assumptions for long-term care cost are based on averages and may not be reasonable for your particular situation. In this case, feel free to make assumptions you believe to be more appropriate. Also, if you believe you have a better approach for estimating long-term care costs, please let us know what you do so that we can share your approach with others.
You should enter your desired estate to be paid at the end of your lifetime planning period. Note that the spreadsheets do not ask for a present value amount for this item, but an amount in real (inflation-adjusted) dollars. Also, because you are likely to have unspent assets at your death, we recommend inputting an amount less than your desired amount for this item. Unspent assets that may be available at the end of your life may also be available to reduce your expected long-term care costs.
Impact of Estimated Long-Term Costs and Bequest Motive on Your Recurring Expense Budget
If the present value of your expected home sale proceeds exceeds the sum of the present value of your long-term costs plus the present value of your desired estate, the excess may be used to increase your recurring expense budget. Note, however, that this can create potential cash-flow issues if you run out of other assets prior to the sale of your home.
If the present value of your expected home sale proceeds is less than the sum of the present value of your long-terms costs plus the present value of your desired estate, the shortfall will decrease the recurring expense budget data point developed under the Actuarial Approach. The impact of this decrease on your spending budget will depend on how you employ the actuarial budget benchmark (ABB) data point calculation in determining your annual spending budget.
Conclusion
Many individuals and couples own their homes. As we saw in the Bureau of Labor statistics discussed in our post of December 22, 2019, most households over age 65 own their homes and generally have significant equity that can be used to fund recurring and non-recurring expenses in retirement. We encourage you to make reasonable best-estimate assumptions about your future long-term care costs and bequest motives to see if your home assets can be used to fund some or all of these costs and perhaps increase your current recurring spending budget.
