What Could Go Wrong – Part II
Welcome back! In this post, we continue talking about the financial shocks that could derail your retirement – and what you can do to protect yourself. Read the first post here.
Long-term care
We left off the last post with a discussion of the importance of good health insurance – fortunately largely covered by Medicare for most people over 65 (and by Obamacare for those under). But what about long-term care? If you’re 65, there’s a 50/50 chance you’ll need it someday. It’s not cheap; the median cost is $85,800 per year for care in a nursing home, although there’s significant variation by state (average cost in Texas is $54,800, Connecticut is $150,200). Assisted living costs average $46,000 per year. Home health care can be less – or more. Health insurance, including Medicare, does not cover the cost of long-term care. (It covers nursing care, if medically necessary for recovery from an injury or illness, but not custodial care that you need because you could use some assistance in daily life.)
To insure against the need for long-term care and its potentially devastating effect on your finances, you can buy long-term care (LTC) insurance. LTC insurance is not cheap – it costs thousands of dollars per year – which is probably why only about 7 million Americans currently have it. Premium costs depend on your age when you first get the insurance, how much coverage you buy (dollars per day and number of years), inflation adjustments to benefits, and other factors. You can control costs by buying it when you’re younger and insuring for something less than full expected assisted living costs (you can pay some from other sources). Couples can sometimes purchase policies that allow “sharing” of benefits between spouses, which might make you feel more comfortable purchasing shorter coverage periods.
Other strategies for covering potential LTC costs include (1) “self insuring,” (i.e., not insuring!), planning on paying any costs out of your income and assets (this strategy obviously works best if you’re wealthy); (2) counting on family members for care; or (3) relying on Medicaid. Most of us would rather not be a burden to our children, who have their own lives and families to take care of. Medicaid does cover a large portion of LTC costs today (43% of all LTC costs, 62% of nursing facility costs). But remember, it is a program for the indigent. To qualify, you will need to spend your assets down to practically nothing. This is not the end-of-life situation many of us would choose, and could leave a surviving spouse in an untenable position.
Another increasingly popular option is “hybrid life insurance,” which combines life insurance with LTC benefits. However, this costs two to three times as much as standard LTC insurance for equivalent benefits. (It does, however, provide a death benefit to your heirs, which regular LTC insurance does not.)
For most of us in the middle – neither very wealthy nor poor – LTC insurance is probably the best strategy. Limit the daily coverage amount and number of years of coverage, and if possible start it in your 50s, to keep the premiums affordable.
For younger folks, there is hope for plugging this big hole in our social safety net. Hawaii and Washington have recently passed laws creating limited long-term care insurance sponsored by the state. Washington’s program is funded through a modest payroll tax. We can hope that within five or ten years a Federal program might come to be that would provide long-term care for all.
Insurance you may not need as a retiree
The observant reader will have noticed that I have said nothing about some fairly common types of insurance. This is because your insurance needs as a retiree and (ahem!) senior are not the same as when you were younger. Life insurance is vitally important when people are in their working years, especially if children (or other dependents) are involved. A substantial life insurance policy can help to keep a bereaved family from having to sell their house, and the surviving spouse from having to take on three jobs to make ends meet. But if your working years are behind you and your kids are grown, you may not need it any more. Your spouse will continue to receive pension and social security benefits when you’re gone (although income will likely be reduced), while the grown children are no longer dependent on you. When your term is up, just let that life insurance policy go!
Disability insurance is another type of insurance that’s valuable to younger adults who have people depending on them. An accident or illness can disrupt your ability to work, perhaps permanently. Yet you still have living expenses, perhaps including significant medical costs. Disability insurance, often available as a benefit option through an employer, can greatly cushion this impact. Like life insurance, disability insurance insures your future earning capacity. It is especially important for young families – but pointless for a retired person.
Vision and dental insurance are common supplements to health insurance. You need these, too, right? Not necessarily. Vision and dental insurance don’t really function as a means to pool risks to protect you against low-probability catastrophes. Root canals, while a bummer, usually don’t rise to the level of a serious threat to your financial well-being. Typical dental insurance might involve a premium of $500 or so per year, and in return pays a percentage of your dental costs up to some cap – say $1,500. At the extreme, you could come out ahead $1,000, or end up down $500 – not enough to knock most people off course financially. These types of insurance are more of a means of evening out expenses that are fairly predictable, and usually manageable. Evaluate what you think their costs and benefits are likely to be for you and make a decision – but don’t think of them as important risk management tools.
Have a Plan B for the ‘Unknown unknowns’
So, if you take out insurance against all the possible disasters described above and in the prior post, you can relax and rest easy, right? Well, not exactly. Life can throw us curveballs that are (perhaps fortunately!) beyond our poor imagination to anticipate. The stock market could crash, a child could become disabled and move back in, or your house could suffer serious damage from an earthquake — after you concluded that earthquake insurance was simply too expensive. While I don’t recommend that you lie awake at night dreaming up disaster scenarios, it is helpful to have a backup strategy or two in case something unexpected goes wrong.
First, conduct a brief thought experiment. Suppose the stock market goes down 50%. (This is not some unrealistic scenario; the S&P index lost 50% as recently as the bear market of 2007-2009.) You hear pundits saying stocks may stay down because this is really their true value/China is eating our lunch/there are too few workers and too many old people/trade wars will prevent recovery/the financial system is broken beyond repair (take your pick). What effect would this bear market have on your retirement portfolio? (If you had a 50/50 stock/bond allocation, your portfolio would drop by about 25%.) How would you react – stay the course, confident that eventually the market will recover; or cash in and buy CDs to protect your (remaining) hard-earned savings? If you think you might be tempted to cash in, consider adjusting your portfolio now to a level that feels safer. Remember, the 4% rule holds for allocations between 30% and 75% stocks – so choose a level you can live with.
“First, conduct a brief thought experiment. Suppose the market goes down 50%”
Let’s suppose you suffer the loss described above, perhaps permanently. (Maybe it’s earthquake damage, and your uninsured home repair costs are $250,000.) Would you be able to make adjustments? There are several ways you might adapt:
- Reduce your living expenses. Could you cut back to, say, 75% of what you currently spend? First consider a temporary cutback (you might defer travel, stop eating out, defer home improvement, draw on your emergency fund [you have one, right?], perhaps take out a loan). Then imagine this same shortfall is a permanent reduction in your standard of living. The actions you take may be quite different.
- Go back to work. This is most practical if you’re only a few years out of the workforce. It’s probably not realistic to think you could earn your previous salary. Would you be willing to do this?
- Sell your vacation home. Obviously, you would have to own one! Selling property would raise capital (replacing some of your unexpected loss) and reduce some ongoing costs (property taxes, utilities, maintenance, HOA fees).
- Downsize – and possibly move — to a less expensive home. Many retirees’ most significant asset is their home. You could potentially realize a significant gain by moving to a smaller place and/or a cheaper area – but you’d be leaving your memories and your network of friends behind. Plus, you’d need to go through all that stuff in the attic!
- No doubt you can think of other ways you could save money…
The point here is not to lament and gnash your teeth over the things you might have to give up, but to consider whether you have the flexibility to deal with a financial setback should you experience one. I suspect most people could adapt if they had to, although a big, permanent income reduction might involve some painful choices. If you’re not sure you could adjust, consider how you might build up a financial cushion in case things go awry. At a minimum, you should have an emergency fund that could cover at least six months of expenses.
One other strategy to consider is front-loading your retirement risk. You’re going to be better able to deal with adversity and adapt to financial setbacks in your 60s than you will be in your 80s. (Example: the going-back-to-work option is a lot more feasible when you’re younger.) Also, identifying that your retirement plan is going awry fairly early on gives you more time to do a course correction.
A couple of ways to front-load risks are to defer taking Social Security as long as possible and to make sure your pension benefits cover the surviving spouse. You could also consider a deferred annuity that doesn’t begin until you’re 80 or so. All of these measures lock in more reliable income in your 70s and beyond, at the cost of reducing near-term income – a solid risk reduction strategy.
Conclusion: Prepare, but don’t obsess
Thus ends my litany of disasters and catastrophes that could drive your retirement vessel from sunny climes and calm waters into storm-tossed seas and possible shipwreck My purpose is not to make you lie awake nights worrying about possible calamities, but to encourage planning and suggest actions you can reasonably and practically take to protect yourself. Not all the types of insurance and risk mitigation I’ve suggested will be right for you, but all retirees (everyone, in fact) should consider the possible risks they face and make the risk management choices that best suit your circumstances. Once you’ve done this, you’ll sleep easier, knowing you’ve done what you can to safeguard your future.
I leave you with one more mournful folk tune about a poor soul enduring life’s travails. Don’t let it be you “travelin’ through a world of woe” in your retirement! Take some simple steps to manage those big risks and enjoy a happy, worry-free retirement.
References
Cohen, Rachel M. (2019, April 26). Washington Becomes First State to Approve Publicly Funded Long Term Care. The Intercept.
Kaiser Family Foundation. (2017, June 20). Medicaid’s Role in Nursing Home Care.
Nguyen, Vivian. (2017, March). Fact Sheet: Long-term Support and Services, AARP Public Policy Insitute.
Rappaport, Anna. (2017). Shocks and the Unexpected: An Important Factor in Retirement, Society of Actuaries.
Stark, Ellen. (2018, March1). 5 Things You SHOULD Know About Long-Term Care Insurance. AARP Bulletin.
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