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Planning for Healthcare and Long-Term Care in Retirement

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Healthcare and long-term care expenses are among the biggest line items in many retiree budgets. Joining me to discuss how retirees should approach them is Carolyn McClanahan. She is director of financial planning for Life Planning Partners, and she is also an MD.

Carolyn, thank you so much for being here.

Carolyn McClanahan: It's my pleasure. Thanks for having me.

Benz: Carolyn, I'd like to talk about how you help your clients estimate their in-retirement healthcare costs. First, let's talk about all of the out-of-pocket expenses that retirees might be liable for, the things that aren't covered by Medicare.

McClanahan: First off, a lot of people actually try to go without Medigap policies, and that's a shame. It should never happen, because if they do that, their out-of-pocket costs can be astronomical and go on forever. But most people, especially advisors, are good about making certain their clients have that coverage. The big out-of-pocket costs are incidentals, but even bigger are the things like dental care and hearing aids that people generally don't think about until they need them.

Benz: How do you think about budgeting then for those items? How much should retirees allow for in their budgets to account for those costs?

McClanahan: The problem with those two things, dental and hearing aids, is they tend to come in big chunks. All of a sudden you need a hearing aid and it's $4,000. I like to think about those like we think about a roof, like we think about replacing an air conditioner. We don't account those in ongoing expenses as far as medical. For all our clients we have what we call basically an emergency fund that would pay for those expenses.

Benz: That makes sense. Now, you mentioned Medigap policies, the idea of having a supplemental policy alongside Medicare. How much should retirees budget for such a policy if they wanted to be fairly comprehensive?

McClanahan: The first thing that we do with all our clients is make certain that we understand their healthcare mindset and how they are going to utilize the healthcare system. If you have people who have what we call a low healthcare mindset--they go to the doctor only when needed and they are OK staying in network and they don't want to access specialty care outside of their network--then that allows for a less expensive Medigap type policy. If they want to know, for example, in Jacksonville, Florida, we have Mayo Clinic. If they want a policy that they know covers Mayo Clinic or will pay for care outside the system, it's going to be more expensive. What we do is just look at the current rates of those policies and that's what we budget.

Benz: You haven't touched on prescription drug costs that might not be covered by Medicare Part D. How do you approach that question in terms of budgeting with your clients?

McClanahan: Everybody, just like they should have a Medigap policy, they should also have a Medicare D policy. Even people who are healthy and aren't on drugs, you don't know when your health is going to go away, especially things like cancer treatment because that tends to, you all of a sudden find out, hey, I have cancer. The drugs that people can be put on could be very expensive. The good news about Medicare D policies is you can change them yearly. It's important to search for a policy that covers what you need. If you have specialty drugs that are not covered by Medicare D policies, for example, there is an eye drug for treating macular degeneration which can't get covered, then that needs to be put in the budget.

Benz: I want to talk about healthcare inflation. What do you see when you are looking at trends in terms of healthcare cost inflation?

McClanahan: This question drives me nuts. One problem I have with the world of financial advisors is, we spend a lot of time trying to predict the future that we cannot predict. I have yet to know any advisor that's gotten it straight on the button.

The problem with healthcare inflation is, historically, it's averaged about 7% in the U.S. since the 1970s. If that continues to be the case, it's unfeasible. Within the next 30 years it would take over 50% of GDP. I hate when advisors give clients these big numbers about, this is what you need to have saved for healthcare expenses when number one, you don't know what their health is going to be, and number two, you have no idea what the inflation rate is going to be.

We actually use 3% inflation in our firm. That's the average rate of inflation that we use for everything. The big thing we have gotten away from is trying to predict the future, especially 20 and 30 years out so tightly. We tell clients, this is not something that should be done. If clients are retiring very early, we caution them that they are relying on the world to do what you expect, and that doesn't always happen. Our biggest thing is, trying to get clients to work as long as possible as long as they are healthy because that takes the need for trying to predict the future out of the equation.

Benz: Let's talk about long-term care costs. This is the big wild card for so many retiree plans. I'd like to hear how you approach this question with your clients, because there really are no good answers when it comes to long-term care. The premiums have been going up for people who thought they were doing the right thing by purchasing insurance. If people don't insure, they can be socked with these enormous costs later in their lives. Let's talk about how you counsel clients on the long-term care decision-making.

McClanahan: The first thing, and what nobody has been doing and we've been doing for a number of years now and have finally developed processes around this for advisors, is creating a long-term care plan. The biggest expense around long-term care is actually not planning how you are going to age. What your living situation is going to be; how are you going to make your healthcare decisions; when you're going to quit driving, because that can factor into the cost; who is going to take over your financial care taking. It's important for us to start working with clients early while they are well, before there's any question about what that future is going to look like, because these are the things we can control. We can control those decisions around how we are going to take care of ourselves as we get older. Once we have done that then we talk about how much is it going to cost.

For example, if you have a client that has, what I call blue toe nail syndrome, the person who wants to live in their home until they die and let's say, that person is very healthy, so have a higher risk of dementia. We build in five years of long-term care costs at 24-hour care, home care, and that ends up being a couple of hundred thousand dollars a year. When I show them those costs, it makes them rethink their choices and document their choices. Once we have the situation spelled out, that's where we put the costs to it.

This is a long answer to your question, but I'm going to get to that briefly. If people can self-fund, we make certain that they segregate those assets into what we call long-term care bucket. The family understands that money is intended to be spent on long-term care. If they want, we do like hybrid policies because it's easy to get people to buy those because they know they are going to get something out of them. Regular, traditional long-term care insurance right now, we are having a tough time with it. It's expensive and it's hard to get our clients to buy it. We go through those other two avenues first before we go to traditional long-term policies.

Benz: Let's talk about the hybrid policies. First, if you can explain how they work basically, and I know that there are really two main varieties, and then also talk about how the pricing might compare and the other features might compare to a pure long-term care policy.

McClanahan: Well, basically, we use the combination life insurance and a long-term care policy. We have our clients want some of those policies usually. With $50,000, that can get about half of their long-term care needs met. With $100,000, that usually can fund the full long-term care need. That's a great way to segregate those assets, so that's actually dedicated toward long-term care.

The comparison between your traditional long-term care policy, the long-term care benefits are not going to be as huge. But the thing is, is the clients know that their family is going to get something from that policy if they by chance just drop dead and don't need the policy. With traditional long-term care, the problem is that you are paying into it for a very long time, and as we have seen recently, you never know when they are going to increase the premiums on those policies. Once you have done, we call it one and done with the hybrid policy because we lump sum fund those.

Benz: Right. Now, would there ever be a situation where you would use a hybrid long-term care annuity policy? Have you used those with clients in any situations?

McClanahan: We have not used those, and we have not even evaluated those, because in general, and maybe we need to revisit those things every couple of years. In general, we haven't liked the annuity provisions of the annuities. The answer is, no, we haven't done that, and our person who actually deals with that sort of situation, whenever we have a long-term policy purchase need come up is when we re-evaluate that. We use actually independent long-term care agent that helps us with those decisions.

Benz: When you say you haven't liked the annuity piece, it's just that the payouts on the annuity if someone decides to annuitize, they are just not high enough? Is that the main … 

McClanahan: Yeah. It's just not worth it. Yeah. 

Benz: You sometimes hear these rules of thumb about how much in assets someone would need to have if their goal is to self-fund long-term care costs. What do you think about that idea, and what sort of asset threshold would make sense?

McClanahan: No, I'm not a big fan of rules of thumb. The reason is, everybody has a different situation. For example, we just recently had a new client that said, I don't want to leave any money to my family, and so I'm happy spending down every bit of the money I have for long-term care. As opposed to somebody who may have a certain amount that they could self-fund, but they want to leave a bigger legacy or they want to guarantee some sort of legacy for their children or other people. It's important to take those variables into account. What does the person want to leave and need to leave behind?

One of the things that people don't understand, right now, you have Medicaid. We don't know what that's going to look like in the future as far as paying for long-term care. But right now, almost every institution will take Medicaid, but the problem is, they don't like to take Medicaid. We just help people, you got to have at least two to three years of funding because the institution will let you in and then once you run out of money, then they will let you go on Medicaid. They just want to make certain that they have this first couple of years covered. There's a lot of different variables you have to think about when deciding how much to fund a long-term care policy or even if to buy one. I don't like the rules of thumb.

Benz: OK, Carolyn. Such an important set of topics here. Great insights. Thank you so much for being here with us today.

McClanahan: My pleasure. Thank you for doing this topic.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.