Clients facing crippling care costs? Here's a four-step safety net

26 Jul 2021

The perils of failing to prepare for long-term care provision are obvious.

I recently wrote about this, highlighting the heartache it is causing families up and down the country, as the kids of vulnerable parents are forced to stump up for their inevitably large care bills. In the good old days, it was quite different. When the elderly became too old to work and needed help with fetching the shopping, heavy lifting, or personal care tasks, it tended to be the case that their children were living close by. If they were unavailable, the local community would often rally round. Things are different now.

With technological and economic growth has come more opportunity and choice. Contraception and falling fertility have also meant families are smaller. They can be scattered all over the world. Family members who are close by may well be up to their necks in work or childcare commitments, which makes regular parental care impossible. No wonder we outsource that task to care agencies.

Now that more of us are living deep into our 80s, 90s, and even beyond, planning for care is more important than ever. The costs can be eye-watering. Average residential care home costs amount to £3,552 a month. That’s £802 a week. If you live in London or the South East it could be even higher. A dementia patient in residential care currently pays an average of £851 a week in the South East.

There is no sign the costs will decrease. The UK’s bill for long-term care is forecast to be over 10% of gross domestic product by 2030.

Dementia is a massive part of the picture. Indeed, the likelihood of some sort of dementia is rising almost as steeply as the number of people living into their 90s. Today, 616,100 people are 90 or over, and the number rises by 3 to 4% each year. Incidence of dementia rises steeply as you move through your 90s, meanwhile. Today, 13% of 90–94-year-olds in the UK suffer from it. That percentage rises to 21% of 95- to 99-year-olds, while 41% of centenarians now have dementia. The other problem with dementia is that caring for sufferers takes a heavy toll on family-based carers. When your parent no longer recognises you, the emotional turmoil can be horrendous.

It would be foolish not to prepare for this kind of situation financially. I think it’s worth planning your retirement income provision around four key stages of retirement.

Stage One: Semi-retirement (age 60-67)

More people than ever might need to be thinking about semi-retirement as a result of the pandemic. A recent study by the Institute of Fiscal Studies (IFS) with the Centre of Ageing Better found that employees aged over 65-year-old were 40% more likely to be still on furlough at the end of April 2021 than staff in their 40s.

During semi-retirement, many older workers reduce their hours, explore a portfolio career, or go self-employed (or all three!). They may want to supplement declining paid income with retirement savings. It’s during this period too that drawing on non-pensionable savings make the most sense.

That’s particularly the case if your pension savings are nudging the lifetime allowance, which was recently frozen at just over £1m, supposedly until April 2026. It’s also the case if you want to make defined contribution (DC) pension contributions without hitting the punitive £4,000 money purchase annual allowance.

With these two scenarios in mind, it is far better to be building up what I like to call ‘Retirement Income Bucket #1’, a semi-retirement fund in an investment bond. This wrapper can receive much higher one-off contributions than pensions and ISAs. HM Revenue & Customs (HMRC) has no upper limit – it’s up to each insurer how much they will accept and £500,000 is a common top-end limit.

A popular feature is the annual 5% withdrawal allowance, whereby amounts up to 5% of the initial investment can be withdrawn with any tax liability deferred. If that 5% is not needed in any year, it can be taken forward for future years. That’s an especially useful feature if your portfolio career is a bit ‘feast or famine’.

The tax position when the bond matures is complicated, but with careful planning and the use of ‘top-slicing’, holders may be able to avoid any further tax beyond the equivalent of basic rate tax that the insurer has already paid within the product.

An ISA, by contrast, only allows you to put in up to £20,000 per year, so it’s not quite so easy to build a serious semi-retirement fund with a flight plan of seven years or more.

Stage Two: Active Full Retirement (age 67-77)

During this retirement sweet spot, most people will want to plan for remaining highly active, taking more holidays, and perhaps bringing the extended family together. They might be supporting their adult children with childcare, and perhaps even helping their grandchildren out financially. Perhaps they buy a second home. Perhaps their leisure spending peaks.

One option during this period is equity release, which can free up funds for unplanned lifestyle expenditure, perhaps to help children or grandchildren get on the housing ladder. Equity release can only be explored while the active retirees still live in their home of course.

During this stage too, retirees may need to consider two or more retirement income buckets: buckets #2 and #3. Bucket #2 could be set up to provide guaranteed income to cover essential spending on monthly bills, council tax and the car.

Depending on the circumstances, it might also cover other items many might regard as essential for their sanity, like one or two good holidays every year. Once these have been added up, your clients might want to see if they can fund these essentials from an annuity to ensure peace of mind.

Then there’s Retirement Income Bucket #3 for less-essential lifestyle items: the second or even third holiday, and the occasional bigger expenses such as a new car. Because Bucket #3 demands flexibility, an income drawdown policy might be best. The growth assets underpinning drawdown policies should also cover future cost increases, as well as providing for additional lifestyle spending in retirement.

Drawdown policies are ideally placed for irregular withdrawals as ‘nice to do’ activities and items pop up. They also offer the exposure to higher growth funds, so a good deal of your lifestyle expenditure could be paid for from investment growth in the good years.

You’ll need to work with your clients to arrive at a notional annual maximum drawdown amount that you limit them to in order to ensure they do not run dry before they reach their dotage.

Back in March 2018, The Institute and Faculty of Actuaries recommended a sustainable annual drawdown rate of no more than 3.5% of the entire pot value, assuming that you are going into decumulation at the then-state pension age of 65.

In this scenario, a £100,000 pot in Drawdown could deliver an income of £3,500 per year. In an annuity and drawdown model, would £3,500 be enough to cover your client’s lifestyle expectations, assuming they have £100,000 to put into an income drawdown plan after you’ve helped them to purchase that first ‘essentials’ annuity, and laid money up in an investment bond or ISA for use during flexi-retirement?

Stage Three: Less Active Retirement (age 77-87)

At this stage, holiday and larger lifestyle expenditure tends to level off. Many retirees choose to downsize as the workload associated with running a large family home may start to become too much.

The alternative is to divert lifestyle expenditure towards hiring additional help with cleaning, gardening and perhaps even some cooking and drop-in care. This is the period for inheritance tax planning, drawing up a lasting power of attorney and settling any final changes to wills.

Do not delay. Once other people realise your clients no longer fully understand what they’re doing it will be too late. They might even want to start earmarking Retirement Income Bucket #4 for passing wealth onto the next generation tax efficiently.

It might make sense in the second half of this period to purchase a second annuity, perhaps benefiting from enhanced annuity rates and locking in additional income certainty.

Stage Four – Long Term Care – (age 88 onwards?)

You never quite know when you’ll need long-term care, so that ’88’ number is hypothetical. What we do know is that the average number of years people require long-term care for is rising. Currently, it sits at 3.9 years in the US, according to the Bipartisan Policy Center.

There is scope to create Retirement Income Bucket #5 to build a fighting fund for long-term care provision. However, if you are living in the South East (see above), you probably need to set aside about £180,000 to cover you. That’s a mighty deep bucket. What about long-term care insurance?

Having been in decline on both sides of the Atlantic for more than 10 years since the early 2000s, the long-term care insurance market began to recover in the US in around 2011. It has not really begun a recovery in the UK yet.

On both sides of the pond people were reluctant to pay hefty premiums for something they might not need. In the US, new ‘hybrid’ ‘combo’ policies were created by some insurance companies. They provide coverage where there is a need, or a death benefit if the policy is not used to pay for care.

The complexity of the product has stimulated an increase of specialist advisers and the burgeoning market is now supported by dedicated provider platforms and underwriting protocols. Furthermore, most US plans cover modifications to your home to make it easier to remain there to receive care if that’s your preferred option. It seems clear we have a good deal to learn here.

The only real long-term care insurance offering left in the UK today is a medically-underwritten ‘immediate needs annuity’, which some people purchase just before they go into residential care. It’s normally linked with an adverse medical report and as such it can be priced fairly accurately. It makes sense for some who want to ring fence costs.

From Stage Three onwards, any financial adviser involved in supporting an ageing client should try to involve their family members as early as possible. The adviser must establish what sorts of decisions the family will and will not support, should the client lose mental capability and need long-term care. It is yet another reason to get the next generation involved, even if the conversation is difficult.

by Chris Read, Group CEO at Dunstan Thomas.
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