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on Wednesday, 04 April 2012
in LTC Insurance

Should I Self-Insure for Long Term Care?

Should you consider self-insuring for Long Term Care?

It’s a prudent and logical question for upper-middle and high income individuals to consider as they ponder purchasing Long Term Care insurance as part of their retirement plan. Having helped many such individuals plan for their future long term care needs, I’ve come to the conclusion that many, who think they have adequate capacity to pay for extended care giving services out-of-pocket, haven’t done the math as thoroughly as they should.

When counseling clients, some will say, “I think we have enough in our retirement savings to handle any long term care needs that might arise.” They may be right. With a few follow-up questions, I learn that they might have anywhere between $500,000 and several million dollars in retirement savings and investments. By providing additional information, I’m usually able to encourage a more realistic look at how far their retirement nest egg will last should they need extended long term care. Here are the key cost considerations that are often overlooked.

Realistic Cost Assessment

For most, retirement savings are used to generate income needed to maintain one’s lifestyle, not to be spent down paying for long term care services. For example, a two million dollar retirement portfolio will generate about $100,000 annually, assuming an average 5% return during retirement years, or $120,000 assuming a 6% percent return. Add in Social Security and a pension and let’s assume hypothetical retirement income of $200,000 to $250,000 annually. Unfortunately, the average cost for just one year in a nursing home in 2011 is $85,775. (John Hancock Cost of Care Survey 2011) Fifteen years from now, that annual cost is expected to exceed $171,000 given current trends. With a typical Alzheimer’s condition lasting between 4-8 years, one could incur total caregiving costs approaching $700,000 at the low end and well over one million dollars at the high end. It is likely that one would have to invade retirement principal and diminish one’s lifestyle and independence during retirement if one had to pay for such an extended care need. The cost of insurance, on the other hand, pales in comparison: pennies on the dollar.

Investment “Surcharge” (Opportunity Cost)

Reallocating principal results in lost investment opportunity on those funds. Every dollar of assets liquidated to pay for long term care is a dollar that can no longer be invested.

Tax “Surcharge”

If an individual withdraws funds from a tax-qualified account to pay for care, these funds often are subject to federal taxes. So, if the cost of care is $86,000 per year, an individual in the 28% federal tax bracket would need to withdraw over $110,000 from the IRA to pay that bill. Imagine the impact 15 years from now when annual caregiving costs might exceed $171,000. One would have to withdraw almost $219,000 in order to net $171,000 for the annual nursing home bill. Factor-in state taxes and the picture gets gloomier, so could future changes in tax law–always a possibility.

“Early Withdrawal” Penalties

If one is forced to withdraw funds from a qualified plan prior to age 59 1/2 in order to pay for long term caregiving needs, there may be additional “costs” resulting from early withdrawal penalties (10%) assessed by the federal government.

Liquidation “Surcharge”

If the assets available to pay for extended health care are not “liquid,” such as real estate, stocks and bonds, they may have to be sold at a loss due to drop in market prices at that time. Extended care needs are oblivious to the ebb and flow of the markets and the resulting “cost” could be significant.

Sometimes, professing the ability to self-insure is used to avoid confronting the more difficult issue of planning for extended care and its harmful impact on family caregivers. If that is the case, it’s better to discuss such matters head on rather than miscalculate one’s ability to pay for long term care out-of-pocket with retirement income and savings. The costs to family and retirement security are often much greater than one might think. Which mistake would you rather make? Having LTC insurance and not needing it? Or not having LTC insurance and needing extended care for years?

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