Most of the research about retirement income planning focuses on two of the three significant retirement risks: investment risk and longevity risk.
The third significant risk, which receives less coverage, is the category of spending shocks – spending significantly more than planned.
Around 400,000 older people live in care homes (according to the 2018 Laing & Buisson), and spending on long-term care is one of the most severe spending shocks that can impact retirees.
In our part of the UK, here in Surrey and Hampshire, it’s not uncommon for care homes to charge around £75,000 per year.
Attendance Allowance and Funded Nursing Care can reduce the cost to individuals by up to £12,000 per year, but even with these contributions, the expense is likely to exceed £5,000 per month.
As with most retirement risks, longevity multiplies the risk; it is, of course, more likely that care will be needed for longer if you live for longer.
In the UK, you can’t buy long-term care insurance (apart from in one or two exceptional circumstances), so it’s not possible to pay a premium to remove the risk.
As Mrs May discovered, talking frankly about the cost of care isn’t politically popular, and, it’s hardly been on the agenda in the current election campaign, so we shouldn’t expect politicians to solve this problem for us.
It seems likely that we will need to rely on our investments, pensions, properties and other assets to cover the cost of our care.
So, it’s easy to understand why so many of our clients worry about how long term care could impact on the legacy they would like to leave to their children.
Care planning in retirement
Long-term care is generally defined as requiring assistance with routine activities of daily living for more than 100 days. Any event lasting less than 100 days is not considered to be a long-term care need and will have a smaller financial impact on the household.
It isn’t clear how long the average duration of a stay in a care home is.
The LSE put the figure at 462 days back in 2017, but previous surveys have shown the average duration in a residential home as being 841 days, and 528 days in a nursing home.
However, the surveys agree that it is rare to live for more than six years in a care home.
For most people, the financial impact is only significant, therefore, if they are unlucky enough to require care for several years, so only a relatively small number of people will suffer a long term care spending shock.
However, a lack of planning can create problems as the cost can deplete household assets, or children can feel obliged to make considerable sacrifices to provide their parents’ care – either physically or financially.
Why You Should Plan Early
Planning for the cost of care is an integral part of a retirement income plan. However, it is often overlooked.
Many are unwilling to confront the questions and possibilities related to losing their independence.
Psychologically, it can be challenging to face morbidity as no one likes thinking about the chance they will no longer be able to handle all of the basic activities of daily living effectively.
It’s only natural to believe that this is something that only happens to other people.
The best approach is to include a plan for the cost of care when you are planning for retirement.
It is unlikely that your asset base will grow once you have retired, so you need to be sure that you can cover this spending shock before you stop work, even though you are unlikely to need the funds for 20 years or so.
Psychologically, it may also be easier to deal with the potential need for care from a distance (this recent blog post may explain why)
What’s the Solution?
Only a small number of people will have to pay out large amounts to cover the cost of care, and it is unfair for the highest costs to be paid by those who are unlucky enough to spend an extended period in a care home due to illness or frailness.
The nature of the risk should mean that it is an ideal market for insurance and if insurers are unwilling to step in, for the state to devise a fair system. However, it seems unlikely that the current system will change for the foreseeable future.
The favourable inheritance tax treatment of pensions makes them an excellent vehicle to place investments set aside for care costs, while many of our clients favour using the family home (which also has some handy tax breaks) as an insurance policy to cover the potential cost.
But the solution isn’t to rush to allocate an asset to provide for the cost; as, with most retirement costs, the answer is to put together a comprehensive retirement spending plan, which includes a plan for shocks like long term care.