Assyat David has over 20 years' experience in the financial services industry. She is co-founder and director of Aged Care Steps.
When structuring a client’s retirement portfolio and calculating their retirement adequacy, advisers should not only consider longevity and sequencing risk, but also their client’s fragility risk.
Professional advisers need to rethink their approach to retirement planning to consider the increasing cost of care. The growing cost and complexity of aged care has brought this need for change sharply into focus.
The current retirement planning approach taken by many advisers may fall short of predicting real retirement income needs and leave clients with significant shortfalls, given the increasing burden of aged care costs. The increased cost of care in the later stages of retirement inevitably will influence when clients are actually ‘retirement ready’. Without considering the costs of aged care, advisers could be significantly underestimating client income needs throughout their entire retirement years.
Complexity of care arrangements means that aged care advice must form an important part of the retirement planning process.
The pitfalls of the traditional retirement planning approach
The traditional approach to income needs in retirement is simplified and assumes that retirement is one homogeneous period in a client’s life. Consideration of income needs over the entire retirement lifecycle can be the foundation of quality retirement planning.
Traditionally, retirement planning is based on securing a determined level of income in retirement that may be based on the client’s pre-retirement salary or a given level of income, which represents either a comfortable or modest standard of living in retirement. This income level is generally indexed to inflation over the client’s life. Advisers then calculate the required level of superannuation savings needed for this income stream over their lifetime. This calculated super balance is used to determine when the client is retirement ready.
However, industry standards for retirement living may fall far short of what might be needed to fund aged care, particularly with the emergence of home care, increasing longevity and the rising incidence of dementia.
The three phases of retirement
There are three phases of retirement linked to the retiree’s health. Retirement planning and projections need to consider the income requirements for each of these phases.
An average 65-year-old retiree will have a health pattern as shown in Diagram 1.
The initial period of retirement (Phase 1) is often the focus of discussions between advisers and their clients. It is essentially the ‘fun’ years, with the focus being on travel, spending time with loved ones and basically loving life! The health and wellbeing of clients is good, and the income needs of this phase of retirement are generally well accounted for in the planning process.
As clients experience some disability, their level of activity and therefore spending declines. This second phase of retirement (the ‘quiet’ years) is when clients’ health starts to decline.
The third phase of retirement, when they experience severe disability, can be described as their ‘fragility’ years. This can account for a quarter of their retirement years, where help may be needed with daily living activities. During this time, greater amounts are likely to be spent on dealing with aged care needs.
Spending patterns in retirement are likely to vary over these three phases and resemble a U-shape, rather than the traditionally assumed straight line. This is illustrated in Diagram 2.
To ignore the real pattern of spending and particularly the impact and costs of care in the third phase of retirement, may result in inadequate retirement savings.
Preference for ageing in place
Older Australians strongly prefer to age in place1, rather than move into residential care.
The costs of aged care have been accelerating and are likely to continue to increase at a rate higher than inflation. The opportunities for home care are also increasing and adding to the pressure on retiree household budgets.
Retirees might expect to need increasing levels of support over the last 10-12 years of their life, with many people experiencing high levels of care dependency in the last 4-5 years. This may require:
Additional and increasing income to fund home care costs.
Capital expenditure to make the home suitable for the ageing person (e.g. widening doorways to enable wheelchairs and ramps).
Aged care costs can be difficult to predict and can vary from $100 a week to $5,000 a week ($5,200pa – $260,000pa), depending on care needs and family circumstances. Access to Government subsidies helps to drastically reduce the cost payable by the user, but having adequate savings expands the options available and the ability to control the level and type of care received.
Modest retirement for a single 85-year old only allows $31.04 per week for care/cleaning. This is less than half the basic daily fee for a home package and that’s before extras!
Care costs could be significant for some clients and need to be included when calculating retirement needs and funding strategies.
The third pillar of retirement risks
When structuring a client’s retirement portfolio and calculating their retirement adequacy, advisers consider two key retirement risks – longevity and sequencing risk, which if ignored, could result in the client’s savings running out earlier than anticipated.
There is another retirement risk that is often ignored, which could cause client savings to also run out earlier than anticipated, exacerbating the longevity risk. Care or fragility risk is the third pillar to retirement risk that needs to be adequately considered as part of the retirement planning process.
This is the risk of inadequately considering the cost of care and related expenditure, which could result in clients spending more than projected in the third phase of their retirement and thereby underfunding their retirement needs and/or running out of funds prematurely.
Rethinking conversations with clients
Advisers need to start having these valuable conversations with clients, explaining and planning for the entirety of the retirement experience. This includes discussion around the high probability of aged care needs in the second or third phases of retirement. Advisers should start factoring in the costs of aged care and anticipating home care needs with pre-retirees who are saving for retirement, as well as retirees who are looking at income drawdown strategies.
Advisers can change their client conversation to include:
How clients expect to fund their aged care costs – highlighting that legislation has been shifting towards a greater user-pays basis.
The role of the home in meeting aged care costs – including the client’s willingness to access the equity in their home or preferring to maintain equity in their home as an inheritance for their family.
Ability to rely on family and friends to provide care and financial support.
If they move to residential care, what options they may have for funding the accommodation deposit and ongoing costs.
Demonstrate the value of advice
Advisers need to adapt their retirement planning approach to provide clients with peace-of-mind and quality advice that enables them to make informed decisions when transitioning through the three phases of retirement.It enables advisers to demonstrate the quality of their advice and act in the best interest of clients by starting strategic conversations with clients, which are squarely focused on their changing needs, and not on product or investment advice.It provides advisers with a valuable opportunity to engage with the client’s loved ones, demonstrate the value of their advice and potentially build intergenerational advice opportunities in the future. Retiree and pre-retirees are the bedrock of many financial planning businesses. Complexity of advice needs do not, as many believe, decrease with age. Clients need quality strategic advice more than ever during the later phases of retirement, and the value advisers can offer clients is immeasurable.