Here at myLifeSite, we typically write about senior living and closely related topics such as retirement lifestyles and aging. However, since our founders have a background in finance, and since finance is a big part of the senior living decision — particularly as it relates to life plan communities (aka continuing care retirement communities, or CCRCs) — we like to occasionally write on more financial-specific topics. Such posts are helpful to consumers and even senior living representatives who may not be as well-versed financially. (Like this one on understanding annuities.)

Financial requirements for CCRC residents

If you’re a regular follower of this blog or have spent time on our free resource pages at myLifeSite, then you probably have learned that to qualify for a continuing care contract or lifecare contract, many life plan communities require prospective residents to meet personal financial requirements.

In essence, the senior living provider wants to ensure that, under average circumstances, the community is likely affordable for its residents over their lifetime. Ultimately, this contributes to greater financial stability for the community as a whole and limits the need for resident financial support, which is offered by many life plan communities.

As a part of this financial evaluation process, most life plan communities will ask prospective residents to complete a confidential financial data form. In many cases, the information provided on this form is then entered into a financial software program to help determine potential affordability over the resident’s lifetime in the community.

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Accounting for personal retirement income

One of the things a prospective resident is asked to provide on the form is personal income sources. Among other things, sources of income may include dividends — which are often paid by stocks, stock mutual funds, exchange-traded funds (ETFs), and other types of investments — as well as interest — which is paid on holdings such as cash, CDs, bonds, and bond mutual funds or ETFs. The amount of income recieved from dividends and interest is fairly straightforward because financial statements will show this.

However, other aspects of retirement income are not as clear-cut and could cause the life plan community to essentially double count income if the information is not provided clearly and accurately, or if the senior living representative collecting the information doesn’t fully understand how it works.

The potential confusion comes into play when there are additional withdrawals from investment and/or retirement accounts. There are two ways to think about withdrawals from an account. The first, as described above, is that the account holder may choose to withdraw only the accumulated interest or dividends. In this case, the individual is not selling any additional shares of their holdings to generate income. They are only withdrawing interest and dividends earned ON those holdings.

Yet, many retirees may need to withdraw more than just dividends and interest to meet their retirement living expenses. In this case, the individual may need to sell shares of their investment holdings, thereby reducing the account value on a dollar-for-dollar basis. Those shares may have accumulated in value over the years, as is generally expected and hoped for with long-term investments. Nonetheless, when shares are sold, it reduces the account value by the same amount.

For example, let’s assume a retiree has an investment account or IRA with a total value of $500,000. The account holds stocks, bonds, and mutual funds. In total the account generates dividends and interest annually of about 3% of the account value, or $15,000 per year. But let’s suppose the retiree withdraws a total of $25,000 from the account each year. This means that in addition to the $15,000 of interest and dividends, the investor is selling (or “liquidating”) $10,000 worth of holdings each year, thereby reducing the account value by $10,000.

Here’s where this can be problematic. If the prospective resident states on the CCRC confidential data form that they are receiving total income of $25,000 from the account, and this is only getting counted as income, then it isn’t accounting on the asset side for the $10,000 reduction in account value from selling the holdings.

Looking at it another way, if you consider the $500,000 account to be a pot of money that needs to last over a lifetime, then neglecting to include the annual $10,000 liquidation of holdings is going to make the long-term picture look much better than it is. Over a 15-year timeframe, this would amount to $150,000 of account reduction that is unaccounted for.

(Note: Withdrawals from regular investment or brokerage accounts are taxed differently than withdrawals from tax-deferred accounts, such as IRAs. But taxes aside, the withdrawal concepts discussed here would generally apply the same way to both.)

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Guaranteed annuity withdrawals add more confusion

Tax-deferred annuities* come in many different forms, but the common denominator is that a lump sum deposit or investment into an annuity will grow tax-deferred, which means any growth on your money within an annuity is not taxed until it is withdrawn. Tax-deferred annuities also have a death benefit that is generally equal to the total amount deposited or the current value, whichever is greater.

Here’s where it gets tricky. Some annuities — typically variable annuities whereby the money is invested into sub-accounts that work similarly to mutual funds — offer guaranteed income riders. Depending on when the annuity was purchased, these riders may offer guaranteed income of up to 6-7% per year from a variable annuity. There is far more nuance to it than what is described here, but we’re keeping it simple for this example.

Let’s use the same example as above, but this time assume the $500,000 is in a variable annuity instead of a basic investment account. And let’s also assume that the annuity holder can withdraw 7% of the value each year. Based on $500,000, and not accounting for any additional growth or “step-ups,” this is $35,000 per year, guaranteed by the insurance company.

BUT… this does not mean the insurance company is paying 7% ON the $500,000 account. That would be a deal everyone would likely take — especially in a lower interest rate environment!

What is happening is that the insurance company is allowing the policyholder to take withdrawals from their account of up to 7% each year and — even in the worst-case scenario where the annuity value was to go to zero — the insurance company will pick up the tab and continue paying out the same 7%. The insurance company is essentially making the bet that this would never happen, and thus they would never be on the hook.

Let’s tie this back to a prospective resident filling out a confidential financial data form, and let’s assume that dividends and interest still account for $15,000 per year as in the example above. If they complete the confidential data form showing that they are receiving income of $35,000 per year from their annuity, and the entire amount is getting entered only as an income source, then the calculations will not account for the $20,000 withdrawal each year. Over 15 years, that would reduce the account value by $300,000.

In terms of affordability, this oversight could make a significant difference in the projected affordability versus actual affordability, particularly depending on the long-term performance of the investments in the account.

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Properly calculating retirement income is key to life plan community affordability

In summary, there is a big difference between income generated ON investments and income generated by selling additional shares to generate cash. Anytime an evaluation is being prepared to help determine the affordability of senior living, the calculations must properly take this distinction into account. Otherwise, the actual long-term results could be drastically different from the projected long-term financials, and this could ultimately affect not only the resident but also the financial condition of the retirement community itself.

*Just like with an IRA, any withdrawal from an annuity before age 59 ½ will trigger a tax penalty. Additionally, early withdrawal penalties, or “surrender charges,” may apply within a certain number of years after purchasing the annuity. Annuities may also be owned within an IRA. 

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