I have been a wealth manager for 20 years, and over that period I have been asked countless times, "What is the greatest threat to one’s wealth?" Many people expect me to say some geo-political event such as a nuclear war, others might guess a decade’s long downturn in domestic GDP. While those are both great guesses and would be high on my list, neither are my top answer. The risk I truly feel has the greatest overall potential to wipe out a lifetime of hard earned wealth is expenses associated with long-term care.
Increase in Longevity
Advances in medicine and technology are allowing us all to live longer. This fact greatly increases the amount of years we will all be paying to have professionals help us accomplish our activities of daily living (ADLs). Whether we are in our homes or in a nursing care facility these expenses are staggering. Annual expenses for nursing home care in my area of Central Florida are rapidly approaching $100,000 and will hit this figure in a few short years. If you have worked hard to build a $500,000 net worth, it doesn’t require a doctorate in mathematics to figure out that five years of long-term care expenses would completely wipe out your family’s nest egg.
A decade ago this risk could have been mitigated by purchasing standalone long-term care insurance. However, a great majority of the carriers of this type of insurance have pulled out of this arena because they realized how many people were needing the benefits and how pricey those benefit payouts were. These facts should add more evidence as to the critical nature of this risk. (For related reading, see: What's Killing Long-Term Care Policies?)
Protecting Your Assets From Long-Term Care Costs
One way to hedge against this great threat to our wealth is asset-based long-term care (ABLTC). The primary difference is that the premiums are paid up front in a lump sum. ABLTC has two components: the insurance that covers the long-term care and a life insurance aspect that is intended to return principal in the rare case that long-term care benefits are not needed. The amount returned regarding principal varies, and after years of long-term care benefit payouts this principal return would eventually deplete completely. Therefore, the only possibility of loss would occur from penalties that apply in the first few years for withdrawing from the plan. Don't think of this solution as an expense. Rather, it is a repositioning of your assets. For example, let’s look at how $500,000 in assets might be allocated before and after ABLTC:
Notice that we simply repositioned some of the existing assets, taking portions from a variety of areas to fund the newly introduced ABLTC. This change is extremely wise for most financial plans. Here's why. The following are rates from a fictitious couple, John Doe is 60 and Jane Doe is 62 and both are currently in good health.
Joint Asset-Based Long-Term Care
Death Benefit: $103,500
Coverage Period: Lifetime
Annual Benefit Increase: 3%
3% Increase While in Benefit: Yes
Home Health Care: Yes
Simultaneous Benefit: Yes
Monthly Benefit Table: See Chart
As you can see, if this couple reallocates their assets to ABLTC and they never have any long-term care expenses, these assets virtually don’t grow at all; however, at least their heirs get back the initial premium. Nevertheless, a huge benefit is enjoyed if they do require long-term care. Let’s make a very reasonable assumption that 20 years down the road both John and Jane will require five years of coverage. I realize they probably won’t begin needing benefits at exactly the same time, however, for ease in analysis we will assume they do. This ABLTC covers both, so if they both require long-term care, they will both have it. The expenses that would be covered in the future are as follows:
We can see that reallocating $100,000 of their assets to hedge against long-term care has resulted in $844,000 in coverage (assuming five years of need). This asset has protected $744,020 worth of assets that otherwise would not have been protected. We must subtract out the $100,000 investment. Now let’s dive a bit further to really see if this investment is wise or not. Obviously, we could simply leave the $100,000 in the original assets; let’s see just how well the assets would have to do to break even. In other words, what would the internal rate of return (IRR) of the original assets have to be each year to equal the benefit enjoyed by the ABLTC. Excel can easily assist us in this computation:
The assets we repositioned would have had to generate a staggering 9.31% average annual return every single year for 25 straight years to break even. Keep in mind the ABLTC pays a lifetime benefit; therefore, if either of the insureds required more than five years of care (which easily could be the case), this already amazing IRR figure would be even higher.
In summary, long-term care expenditures are a prodigious threat to our overall financial plan. They can easily wipe out a lifetime of hard-earned assets in a few short years. With a simple repositioning of assets, this threat can be greatly mitigated. The earlier this step is taken the greater the risk is reduced. You owe it to yourself and your family to at least run the illustration using your specific data points. I strongly believe peace of mind cannot be achieved without a significant hedge against long-term care expenditures.
(For related reading, see: A New Approach to Long-Term Care Insurance.)
Above data is pulled for a fictional married couple in good health so that analysis of the solution could be performed, this article does not constitute an offer or a quote for any reader.
Benefits for fictitious couple ran June of 2017 benefits will change (sometimes drastically) in the future.
Article is for general information purposes only. It does not provide specific legal, tax or investment advice.