How Should I Plan For Long-Term Care?

Kevin Michels, CFP ^®_, EA

Over the past few weeks I’ve been working with two different clients helping them come to a decision on whether or not they need long-term care (LTC) insurance.  This is actually one of the most frequent questions I get from clients, and like most everything in personal finance, the answer is personal.  It depends on a lot of factors which we’ll cover in this post.

When clients come in with this question, it usually stems from a personal experience of them watching a grandparent or parent struggle to pay costs for assisted living, home health care, or a nursing home.   It’s expensive!  

In Utah and Arizona (where most our clients reside) the average annual cost of assisted living ranges from $40,000 - $45,000.  Home health care is even more expensive ranging from $54,000 - $57,000, plus the costs of staying in the home.  Those who need the services of a nursing home facility pay on average between $76,000 - $77,000 for a semi-private room and $91,000 - $98,000 for a private room.

Generally, there are two ways to go about preparing for long-term care costs.  You can insure your potential costs with a long-term care policy, or self-insure by saving and investing enough to pay for the costs yourself.  There are pros and cons to both strategies and much of it will depend on your own personal preferences, more so than what is most “financially optimal”.  

Ins and Outs of Long-Term Care Insurance

Less insurance companies offer long-term care policies than they did a decade or two ago.  Over the years they found that they were pricing the premiums incorrectly and their costs to pay benefits exceeded the premiums they were charging.  Currently, there are only a dozen or so companies that offer long-term care policies to new buyers.

Generally, an LTC policy will have stated lifetime benefit with a cap on how much can be used monthly.  For example, the lifetime benefit might be $500,000 with a maximum monthly benefit of $6,000.  Any good policy should have a compounded inflation benefit so the lifetime benefit and monthly benefit at least grow with normal inflation.

There is also a time cap on the benefit.  Generally, you’ll see benefits that last between 36 and 72 months.  Of course, there are policies that can be written for lifetime benefits, but the premiums are much higher.

In order for you to start receiving benefits, you must meet certain conditions.  Most policies require you to need assistance with at least two of the following six activities of daily living (ADL):

• Eating
• Bathing
• Dressing
• Toileting
• Transferring
• Maintaining continence

Once the insurance company has verified that you need help with at least two of the six ADLs, you usually have a waiting period before the benefit will start.  30-90 days is typical for a policy.  The policy will then cover the costs of in-home care, assisted living, and nursing facilities.

Premiums for LTC insurance depend on a lot of factors including your age, your health, the details of the coverage, and your waiting period.  The best time to apply is usually in your 50s.  Premiums usually aren’t fixed and rise over time.  Some policies require that you still pay your premiums while you’re collecting a benefit, while others don’t.  A premium for a typical policy in the $500,000 range with a 5-year benefit for a healthy person would probably cost around $2,000 - $5,000 per year.

LTC insurance is great because you know you’ll have a benefit if and when you need it.  There are a few issues I see with LTC insurance.

Flexibility – Since you can only collect the benefits if you can’t perform two of the six ADLs, there is a chance you may never use it.

Time Cap – With most policies you’ll meet your time cap before your lifetime benefit.  $500,000 might sound like a lot of coverage, but if you can only collect that benefit for 5 years and you pay $50,000/year for assisted living, you end up using only half of your benefit.  

Premiums – Premiums rise as you get older, and generally rise at a faster rate the older you get.  The premiums can be a hard pill for a retiree, especially one living on a fixed income.

Self-Insure

Self-insuring means taking what you would have spent on premiums and saving and investing it instead.  This strategy comes with a whole set of risks itself (which we’ll get into), but does provide an alternative to some of the issues that come with an LTC policy.

The best place to save and invest for future medical costs or long-term care needs is through a Health Savings Account.  Contributions to HSAs are tax-free, growth is tax-free, and withdrawals are tax-free if used for qualified medical expenses.  Notably, while home health care and nursing facilities qualify for tax-free withdrawals from an HSA, assisted living does not.   You can still pay for assisted living through an HSA, but the withdrawals would be counted as taxable income.  In addition, once you turn age 65 you can use your HSA for any expense without incurring a penalty, you simply pay income taxes on the withdrawals as you would with a Traditional IRA or 401(k).

If you’re not eligible for an HSA or you’re already maxing it out and want to save more, you can consider other tax-advantaged retirement accounts or even a taxable brokerage account.

By self-insuring you have the flexibility to spend your money how you want and when you want.  If you never end up needing long-term care you can use your savings for other medical costs or just for living expenses.  You also don’t have a time cap on when you have to use the money, you can make it last as long as you want.

However, by self-insuring you also take on some risk.   Will you have the discipline to save and invest the premium you would otherwise be paying for LTC insurance?   Will you have the discipline to earmark that money for medical and long-term care expenses, or will it be raided for other purposes when the needs arise?  As with any investment, market risk is a concern as well, you’ll be assuming the risk that the money will grow and be there for you when you need it.  A detailed investment plan is vitally important.

Bottom Line

In all reality the way you insure for LTC costs isn’t as important as simply just having a plan.  If you have an existing or potential LTC policy you would like us to review or are interested in putting together a plan to self-insure LTC costs, feel free reach out or reserve some time on our schedule to talk.  We’ll objectively walk you through the pros and cons of your situation and help you come to a conclusion that’s right for you.