Paying for Aging

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.

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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