Unless you’ve been a caregiver or child of someone who required long-term care services, you may not have given the topic much thought beyond the abstract.

Yet, amidst the sea of uncertainties we all face in retirement, the possible need for LTC is one of the major risks to your financial plan. It’s like a financial torpedo on a collision course: it may pass you unscathed or deliver only a glancing blow, but there’s a real chance it could sink your savings, leaving you and your loved ones vulnerable.

What is long-term care?

Long-term care (LTC) refers to a range of healthcare and support services to assist individuals with difficulty performing everyday activities independently due to chronic illness, disability, or cognitive impairment. To qualify for benefits from an insurance or government perspective, an individual must be unable to perform two of the six “activities of daily living” (ADL). The six ADLs include walking, eating, dressing, bathing, toileting, and continence. Diagnosed severe cognitive impairment from Alzheimer’s disease or other forms of dementia may qualify an individual for services if they require supervision to protect themselves or others.

What are the different types of long-term care?

Nursing homes are usually the first thing that comes to mind, but most people never need that level of care. Typically, care begins in the home and is frequently provided by a spouse or loved one before outside help is brought in. If their condition worsens or a caregiver is no longer able to help, they will move into an assisted living facility. Only a subset of individuals requiring assisted living care will progress to a nursing home. Below are the most common forms of long-term care services listed in order of severity.

1. Adult day centers: provide daytime programs for the individual and a respite for caregivers to go to work, run errands, or catch a break.

2. In-home care: support services provided in the home

3. Assisted living: a residential facility designed for some independence with access to help as needed

4. Nursing home/memory care: for residents requiring more complex care management and around-the-clock services.

5. Skilled nursing facilities (SNFs): for patients who require care from licensed nurses in an inpatient setting. SNFs primarily provide shorter-term care for the sickest patients or intensive rehabilitation after discharge from a hospital.

What does LTC cost?

LTC is expensive and it varies widely by location and level of care. An excellent resource to understand the cost of care in your area is produced by Genworth, an LTC insurance provider, which tracks LTC expenditures by zip code: Cost of Long Term Care by State | Cost of Care Report | Genworth.

Below is the average annual cost of care for Charlottesville VA in 2023 and as projected in 2043 assuming 3% inflation. These are median figures, meaning that 50% of providers are more expensive, and 50% are less expensive (including many facilities you would never wish for yourself or a loved one).

To understand the potential costs, you also need a realistic understanding of the likelihood of reaching certain levels of care and the duration. The U.S. Department of Health and Human Services estimates that 69% of retirees will need some level of care. Women tend to need care longer (3.7 years vs 2.2. years). One-third of today’s 65-year-olds may never need long-term care support, but 20% will need it longer than 5 years. (See How Much Care Will You Need? | ACL Administration for Community Living).

The best study I’ve found that estimates the total lifetime cost of long-term care needs was published by the accounting firm PWC in 2016 and updated in 2021 based on data collected from major LTC insurance carriers. The chart below estimates the total costs in 2020 dollars of formal long-term care services over the lifetime of an individual who is sufficiently disabled to begin receiving formal paid care. Estimated costs include both out-of-pocket expenses and those reimbursed by private insurance. It does not include costs paid by government programs like Medicaid or Medicare. It’s also important to note that the data was obtained before the impact of COVID-19 on the cost of services, which has further driven up costs.

According to PWC’s updated study, the median lifetime LTC cost for an individual who begins services is approximately $91k in 2020 (i.e. 50% of claimants incurred costs of $91,000 or less on all levels of LTC). 25% of claimants experienced LTC costs greater than $238,000, 10% experienced costs above $468k, 5% experienced costs above $661k, and the top 1% experienced costs over $1.2 million.

PWC’s full original study also clearly illustrated well-known gender differences. Women tend to need care for longer because they tend to live longer and also experience higher instances of dementia. Cognitive impairment is also correlated with longer durations and therefore higher total costs.

How to pay for long-term care

We know that long-term care costs could devastate you financially, but we cannot know whether you will need it or for how long. LTC insurance is also expensive (if it were cheap, we’d all have it!) and there’s a decent chance you will never need it. If you have a certain level of affluence, you may be willing to take on the risk of self-insurance, but you still need a plan.

So what are the options?

What about Medicare?

It is a widespread misunderstanding that Medicare will pay for long-term care services. Medicare will cover the initial 100 days of rehabilitative care in a skilled nursing facility following hospitalization. Medicare may also pay for certain home healthcare services (skilled nursing or therapy) to treat illness or injury if ordered by your doctor. Medicare will not pay for an aide if you only require personal care and do not need skilled care.

1. Government-funded insurance:

   Medicaid will fund LTC services, but you must first consider the stringent requirements and significant tradeoffs that come with it. Medicaid is meant to be a safety net for those who cannot afford care, and therefore you must have very few assets and meager income to qualify. If you attempt to “give your money away” to children or others to meet the requirements, Medicaid can look back over the five years to see what money you’ve gifted that could be clawed back. By relying on Medicaid funding, you will also give up greater control over the facilities that provide your care. Therefore, spending down your assets to qualify for Medicaid is typically a last resort.

2. Self-funding

   There are two main ways to self-insure. If you have sufficient assets, you may want to set aside a portion of your portfolio (typically in an IRA or HSA account) which you will only tap if there is a need for LTC services. Because you can never be sure whether you will need these funds, you must resist the urge to spend this money. If you end up requiring limited LTC services, these assets will be passed to your beneficiaries. If you can’t pre-fund LTC needs, the second option is to build one up over time through regular savings and investment.

   Under either approach, the amount you decide to set aside or save depends on your other income sources (pension, social security, rental income) and other assets you could liquidate if needed, like your home. You will likely need to rely on a reasonable assumption for investment returns to meet your goal and keep pace with inflation, and then actually achieve those returns. Behavior and psychology play a major role in investing success too. Can you stick to a savings and investment plan over the long haul? If not, perhaps the “forced savings" aspect of insurance premiums would more likely lead to success.

   Setting up a separate IRA or HSA account that is earmarked for LTC needs provides a sense of security and can make it psychologically easier to draw on these assets when/if needed. Often individuals who decide to self-insure will wait too long to seek help because they don’t want to draw on their assets for services that seem so expensive. This can lead to greater isolation, unmet needs, and lower quality of life for both the individual who has declined and their caregivers (often their spouse or adult child). Separating funds earmarked for LTC care from those required for retirement income can help families overcome the mental hurdle of seeking care.

3. LTC Insurance

   If you cannot fully self-insure or want to transfer the risk, the third option is LTC insurance. Even folks who could afford to self-insure may prefer to offload this risk to protect their assets or for peace of mind.

   LTC insurance typically takes the form of a certain monthly benefit for a certain term. For example, a policy may pay $6,000/month for four years, for a total benefit of $288,000. If your monthly needs are less than $6,000, you could receive benefits for longer than four years. The term just refers to the length of time you would receive benefits if you received the monthly max.

   There are two main forms of LTC insurance: Traditional and Hybrid LTC (and there are endless ways to customize each)

   Traditional LTC Insurance

   Also known as “pure” insurance, traditional LTC policies function similarly to disability or car insurance. You pay a premium and receive a predetermined benefit only if you meet the requirements for a claim (inability to perform two of the six ADLs) and after an elimination period (which functions like a deductible).

   Like car insurance, traditional LTC insurance is “use it or lose it.” On average, you should expect your claims to be less than the premiums paid. That’s how all insurance works (and how insurance companies stay in business). Typically the starting premiums are much lower than hybrid policies, but they’re also not guaranteed, meaning they can increase. Individuals who bought traditional LTC policies before 2008 may have seen their premiums grow to more than double or triple their original rate because of the low-interest rate environment that lasted well over a decade combined with increased longevity and claims. More recent policies tend to be better priced from the outset (i.e. higher premiums) than they were decades ago, but that doesn’t mean they won’t increase in the future. If you are not prepared for this, the premium increases can lead to policyholders surrendering their coverage in their late 70s and 80s, just before they are statistically likely to need it.

   Hybrid LTC policies (also known as “asset-based care”)

   Hybrid policies combine features of whole life insurance with traditional LTC insurance. Like pure LTC policies, a hybrid policy will have a stated monthly benefit, term, and maximum benefit amount. However, these policies also have a death benefit and create cash value like other forms of permanent life insurance. Meaning, that if you die without claiming any LTC benefits, your heirs will receive a specified “death benefit” similar to a life insurance policy. If you change your mind and surrender the policy, you will receive the accumulated “cash value.” Both the death benefit and cash value will be reduced by any LTC benefits paid out while the policy is in effect. Once the death benefit is exhausted by payouts for LTC, the policy will continue to pay out benefits until the maximum LTC benefit amount is reached.

   These hybrid policies typically have guaranteed premiums, meaning premiums are fixed at the outset of the contract and will not increase. Hybrid LTC policies give the holder more flexibility for how they will receive their benefits, mitigating the “use it or lose it” quality of traditional LTC policies.

   There’s no magic here though, you will pay for that optionality with higher premiums. Still, there are many ways to adjust a hybrid policy to approximate your desired balance between making sure you’ll be okay if you need care and passing on more money if you don’t.

So, what’s the best way to protect against the financial risk of needing long-term care?

There’s no right answer (at least not one that we can know ahead of time). Of course, if we knew when you would need care, what kind of care you will need, and for how long, then there would be an optimal way to finance it. Unfortunately, we don’t get to know that!

But, we can look clear-eyed at the range of possible outcomes and look introspectively at our attitudes toward risk and lived experiences to create a plan. It’s better to do this sooner rather than later too. If you wait until you need care, you will likely have narrowed your options considerably.

Almost all insurance decisions tend to reduce along similar lines:

1. If you don’t need it, you would have been better off not doing anything

2. If you need it sooner or for longer, or your investment returns stink, you will be glad you have insurance

3. If you need it later or for shorter, you (and your heirs) would have been better off self-insuring and investing

Insurance works best to cover risks that are both low in frequency and high in severity (car accidents, house fires, premature death, or disability). This is why LTC is so difficult to plan for: It’s not all that low in frequency, but it can also wreck your retirement plan. These two things conspire to make LTC much more expensive to insure against (whether that’s self-insuring or purchasing an insurance policy).

Like most things in life, uncertainty reigns and there are always tradeoffs. We cannot know the “right” answer, except perhaps in the rearview mirror. Therefore we’ve got to hold two opposing ideals at once: make a good plan, then learn to embrace uncertainty.