I recently was asked an interesting question by a church friend concerning his elderly mother.
Like many of us, he is a 'boomer' and has an 85-year-old mother who currently lives in an assisted-care facility. Her expenses are being paid for by Social Security, a military survivors pension, and long-term care (LTC) policy. Her living expenses are very high, which is mainly attributable to the high cost of living in the area where she resides and the fact that she is in assisted living.
My friend's inquiry was due to the fact that his mom's LTC benefits will soon run out (yes, most LTC policies have monthly and lifetime benefits caps) and he and his family are trying to decide what to do to make sure she is taken care of.
This is a common issue
There are a LOT of 'boomers' out there (people in their 50s and 60s) with parents in their 70s, 80s, and 90s, so this is not an uncommon problem. Perhaps you and your family are facing a situation similar to my friend's and are trying to decide what to do.
My friend's mother (I'll call her Susan) recently sold her house at a nice profit. Because it netted several hundred thousand dollars, his question had to do with what to do with the money to ensure that she will continue to receive the care she needs for the rest of her life.
Susan was fortunate to have significant equity in her home. Since she wasn't living there, she could have elected to keep it and rent it out (and accept the headaches that come with that). Given the value of the home and its location, it would probably have produced a nice rental income. If Susan were still living in the house, a reverse mortgage would have been an option.
In this article, I want to discuss these situations in general, and my friend's in particular, which I will return to at the end of the article. As always, the information I present is for informational and educational purposes only. You should consult with a licensed professional before taking any action.
This can be a big challenge
Our elderly parents' income can fall short of expenses for any number of reasons. The worst-case scenario is running out of money before they 'run out of life.'
In these situations, some families are in a position to financially provide for their aging parents or to take them into their homes to care for them. This kind of family involvement would have strong biblical support, especially in passages like 1 Timothy 5:8:
But if anyone does not provide for his relatives, and especially for members of his household, he has denied the faith and is worse than an unbeliever. (ESV)
This passage seems to mainly be speaking to heads of households regarding their nearest relatives, so I think that includes parents and grandparents. That said, I think most parents don't ever want to become a burden to their children or others, but as we all know, life is unpredictable, and circumstances can change quickly.
This is a challenging situation, and there isn't always an easy solution. It typically involves reducing expenses or finding other sources of income or both. Coming up with a way to deal with this will need to be based on their particular situation and also take into account their specific desires and goals.
A paid-for home is a wild card
To help with this, I want to describe a couple of different scenarios for a fictitious elderly parent named 'Diane.' They are the same except for the variable of home ownership. Home equity is a primary source of income for retirees, and as we shall see, not an insignificant one. In fact, it can be the 'wild card' in this kind of situation.
Scenario one: Savings have been exhausted; their only income is from Social Security and perhaps a pension – your parent does not own her home.
Depending on the amount of Diane's guaranteed retirement income, this can be a very challenging situation. For example, lets say that Diane, who is your 85-year-old mother, receives a Social Security benefit of $11,000 per year, has a small pension of $6,000 per year, and had also been spending an additional $18,000 per year (9 percent) from a $200,000 nest egg, which she has almost depleted.
Diane's yearly income is going from $35,000 to $17,000, which is not going to be enough to cover her living expenses.
Such a dramatic income reduction is a situation where the family will have to step in and help. If Diane is part of a church community, help may be available there as well. If not, then she will probably have to move to low-income housing and take full advantage of all the government assistance available to her, including Medicaid if she ever needs assisted-living or nursing home care.
Sadly many families have loved ones who are in this situation. The best solution would have been to manage Diane's $200,000 nest egg to ensure that she didn't run out of money. Annual withdrawals of 9 percent are not sustainable over an extended period. (Remember, a "safe" withdrawal rate is generally considered to be 4 percent or less.)
Scenario Two: Savings have been exhausted; their only income is from Social Security and perhaps a pension – your parent does own her home.
In this scenario, Diane owns a paid-for house. Home ownership is a significant factor because she may be able to use the equity in the home to make up the shortfall created by running out of her retirement savings.
One way to convert home equity to income is with a 'reverse mortgage.' That can be a good option, especially if Diane wants to continue to live in the home and can do so. (I haven't written much about reverse mortgages, and I have to confess that I'm usually not a big fan, but there are situations where it is the only solution.)
If the value of her home is $350,000, according to a rough estimate from reversemortgage.org, Diane could withdraw approximately $20,000 a year for ten years before she would exhaust her available reverse mortgage principal of $200,000. At that time, assuming the house increases in value a modest 2 percent a year, Diane could still have around $200,000 in home equity remaining.
That would result in total income of $37,000 a year while enabling her to remain in her home. But what if she would like to live (independently) in a rented apartment?
In that case, she could sell the house and use the proceeds to help fund her additional rental expense. If the $350,000 is spent down at a rate of $35,000 a year for ten years until she is 95 years old (assuming you kept it in an FDIC insured cash account only), it would increase her annual income to $52,000.
A significant drawback of this option is that Diane will run out of money by the time she turns 95. It will last longer of course if she reduces her annual withdrawals, which may be possible depending on her rental expenses.
What if Diane needs assisted living or nursing care?
If Diane needs assisted-living or nursing services, her financial situation becomes more challenging. The costs for this kind of care are very high and therefore prohibitive for most people unless they have significant financial reserves or long-term care insurance.
If she needs to move to an assisted-living facility, her living expenses will be much higher. According to the Genworth Cost of Care Survey for 2017, in Charlotte, NC, where I live, it costs on average $3,755 per month ($45,700 per year). Nursing care in a private room costs a whopping $7,635 per month ($92,020 per year).
Based on those estimates, she could afford assisted living care for approximately ten years. However, nursing care would exhaust her $350,000 in savings in about 4 ½ years.
Diane's other options
At this point, Diane's personal preferences and desires come into play. Is she willing to move in with a family member if that is something they are eager to do? How does she feel about putting money in the stock market? Does she want to live on interest and dividends and not touch the principal so that she can leave something for her family? How does she feel about hiring a financial advisor?
Unfortunately, Diane doesn't have a lot of options. If she cannot – or does not – want to move in with a family member, and invests her money conservatively in insured bank accounts and CDs and tries to live only on interest, she can currently get at best about 2 percent per year, which only amounts to $7,000 per year. Even when combined with her other income, she would still have an annual shortfall of $22,000. Unfortunately, that takes the interest-only option off the table.
If she is more aggressive in investing her money in stocks and bonds, she may be able to get average returns of 4 to 6 percent per year, but that may be overly optimistic. Furthermore, she would have to be very confident (and take on a lot of risks) to get the 8 percent ($28,000 per year) she needs to pay for assisted living.
Does Diane need an annuity?
In scenario #2 above, I described a scenario where you have a sum that you invest conservatively and then spend from until it's gone. But the problem with such an approach is just that – at some point, it's gone.
There is another option that a lot of people never consider: a simple immediate life annuity. A simple annuity would pay Diane a fixed monthly income for the rest of her life, regardless of what happens with the economy or the stock market.
The reason this option of often overlooked is the deservedly "bad rap" that a lot of annuity products get. I have previously written about the simple annuity's more complicated and costly cousins, but this may be the best-case scenario for the right kind of annuity.
Recall that Diane needs a total yearly income of $45,700 for assisted living, and $28,700 needs to come from her home equity. A quick check at immediateannuities.com, a low-cost online annuity service, shows that $200,000 would purchase an annual lifetime income of $27,432 (a 13.7 percent payout rate). That would give her a combined income of over $44,000 a year. And note that she still has $150,000 in savings.
That seems to be a "too good to be true" solution to Diane's income problem, but is it? Well, it's a good solution, but there is a negative, which can be a show-stopper for many people.
When Diane passes, her money is gone – there is nothing to leave to her family members. That's how annuities work (although in return for a lower payout, some unpaid benefits could be passed along to her heirs).
In return for handing over a pile of money, she gets a nice income for as long as she lives. If she dies in 5 years, the annuity will seem like a bad idea as she will only receive $137,000 of the $200,000 she spent. But if she lives to be 100, it could be her smartest financial decision ever as she will recoup all of her investment and a lot more (a total of $411,480).
If Diane's family can convince her that they are more concerned about her financial well-being while she is alive than her ability to leave a legacy after she is gone, she may be persuaded to go with the annuity.
Purchasing an annuity can be a wise choice, and it's not "gambling," even though it does involve making some assumptions about how long the purchaser might live. We know that we can't predict the future, nor should we presume on it (James 4:13-16), but we can make the wisest, most informed choices possible and then trust God for the outcome.
Back to 'Susan's' situation
'Susan's' situation very similar to the fictitious one I just walked through for 'Diane.' My friend and his family need to decide how to best use the proceeds from the sale of her home to help fund her remaining years in assisted living (and possibly nursing care in the future).
In his case, it just isn't possible to produce enough 'safe' income without accessing principle. So, one option is to create a 'personal annuity' by conservatively investing the money and then spending it down in a way that makes it last as long as possible. Care has to be taken to ensure that they invest it wisely and don't draw down the principal too quickly.
The other option is to purchase an immediate annuity to ensure that she would never run out of money. In our imaginary scenario, we did not use all of Diane's savings to purchase the annuity. Similarly, it might make sense for my friend only to devote what is needed to produce the required income and invest the rest. In fact, if the annuity generates enough income, the remaining money could be invested more aggressively. If the markets provide favorable returns, you could have a larger nest egg that could be used later on or passed on to heirs.
My advice to my friend: Consider these options and find a trusted advisor (preferably one who is not paid on commission) to help you make the right decision for your mom.