A few perils brought on by not incorporating the full range of your retiree client’s future health care costs into their retirement plans

Today’s retirement plans are often very sophisticated in many ways.  Estate plans, extensive asset analyses, what-if scenarios, tax analyses, spending broken down into much detail, percentage chances of meeting goals, and even a series of annual costs representing some of the health care costs your clients may incur are often parts of a modern retirement plan.  However, there is one critical component of costs that is mostly not fully recognized – the range of possible future health care costs, including the very variable long-term care costs.

Although all health care costs can significantly vary from year to year (hospital stays, the incurring of new chronic conditions and their associated prescription drug costs, and many others), the most variable is long-term care costs.  These long-term care costs can vary from zero to well over a million dollars over the course of your client’s lifetime.  It is impossible to pin down the costs to single amounts each year with any accuracy; the best that can be done is to produce probability distributions of future long-term care costs.

So, what can go wrong if the costs are depicted in the plan as something other than series of costs along with their associated probabilities of occurring?  Here are just a few:

1.       A long-term care event can easily exceed the amount assumed to be used for expenses in a given year.  The extra expenses can take a big bite out of the asset portfolio, leaving the client in a worse position than the plan’s projection.  The spending for all the previous years was calculated ignoring the long-term care event.   But the event may or may not occur, adding uncertainty that is not addressed in the retirement plan if probability distributions are not employed.

2.       The computation of the chances of success of the plan, including not outliving assets, is greatly influenced by long-term care costs.  My research shows that a computation of success without recognizing the full range of long-term care costs may be 90%; incorporating the full range of these costs can bring down the success rate down to under 50%!  The actual size of the asset portfolio is a key determinant of the impact of long-term care costs on success rates.  This is a complicated topic and I will have another blog on it.

3.       I can imagine the dissatisfaction of the clients who were expecting to not outlive assets but now find themselves in trouble because of long-term care costs (let alone their expected legacy!).  By recognizing these costs in the plan and adjusting spending, the chances of success can be computed more realistically. 

4.       The doozy is not to plan for the contingency that there will be someone who lives long with a long cognitive impairment. This often ruins the expected inheritance.  Incorporating probabilities of long-term care costs can give a more realistic picture of the size and chances of this contingency, as well as a more realistic picture of the client’s retirement.  Of course, to analyze this, the probabilities of living to various ages must be incorporated, preferably customized to the client’s health and longevity.

So what is the answer?  Prepare probability distributions of client’s health care costs, customizing them to the client’s longevity and health, and incorporating the distributions into the client’s retirement plans.