Financial Planning, Retirement

Retirement funding models ignoring aged-care costs

Traditional funding models for retirement are not considering the cost of health and aged care despite research showing many people will spend around one-fifth of their retirement years requiring such care.

Additionally, advisers who fail to have conversations with older clients and their families around funding care may leave them exposed, Aged Care Steps director Louise Biti told attendees at the SMSF Association National Conference 2019 in Melbourne today.

Biti said advisers were familiar with sequencing and longevity risk, but should also start to factor in frailty risk, which is a period of physical and/or mental decline prior to death.

“The chances are there will be a period before death that will be a period of frailty … and we need to face the fact this risk is real and most people will face it,” she said.

She added there were lower incidences of death related to major medical events and people were more likely to recover and then have a period of frailty before passing away, representing around 20 per cent of their retirement.

“Frailty risk can represent 17 to 25 per cent of retirement, depending on gender and life expectancy,” she said, adding research has found most retirees spend the first 10 years of retirement with no aged-care needs, before having limited needs in the next seven years and then having severe needs in the final years of life.

“Generally, this means around 20 per cent of retirement is spent in the frailty period, and that is a large part to leave exposed without a plan about how to deal with those needs and what would change in the structure of a portfolio to provide for those needs,” she said.

Advisers need to factor in what frailty risk means for retirement planning and how it impacts on issues such as drawdowns and capital adequacy, as well as what would a good quality of life look like during a period of frailty, she added.

She put forward a three-phase approach that recognised the higher expense needs of the initial active period of retirement, the transition into a less active period with lower expenses and then the period of frailty, which usually involves increased expenses.

This model rejected the straight-line income projection model currently used and showed income needs to have a U-shape from initial retirement, through the less active phase, before rising in the third phase, she noted.

“A retiree can fund this period cheaply if they take what the government provides in terms of care, but if they want full control of the care and what sort of care they receive, their expenses may skyrocket,” Biti said.

“Breaking retirement planning into three phases helps clients focus on what their needs might be and how they can transition from one phase to another, and helps advisers to review those periods and when they should start or adjust their conversations about the next steps.”

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