According to data collected at myLifeSite, roughly three quarters of continuing care retirement communities (CCRCs), also called life plan communities, require an entry fee. About 80 percent of those communities offer a refundable entry fee option, with 50 percent and 90 percent refunds being the most common. It is not unusual for a single community to provide both a refundable entry-fee contract and a traditional declining-balance contract as alternatives.
What is the best CCRC contract choice?
With so many CCRCs offering refundable-entry-fee contracts, prospective residents often ask whether choosing a refundable contract makes financial sense compared with a traditional contract. To answer that question it helps to understand how the two contract types differ. Below is a concise explanation based on the analysis in the author’s book.
Here is an example of how a traditional, declining-balance contract works:
Imagine ABC Community charges a $260,000 entry fee for a two-bedroom cottage. Under a typical traditional contract, the community amortizes that entry fee over an initial period—commonly four years. If the resident remains in the community beyond that amortization period, there would be no refund available after those four years. During the amortization period, however, a declining-balance schedule would determine a partial refund if the unit is vacated or the resident passes away.
Here is an example of how a refundable entry fee contract works:
Suppose ABC Community also offers a refundable option in which the resident pays $360,000 and is guaranteed at least a 50 percent refund. In that case a minimum of $180,000 would be returned when the resident vacates the unit or upon death, and sometimes more if the refund structure or timing allows it.
From a resident’s perspective, the decision becomes: is it worth paying an extra $100,000 (bringing the total to $360,000) to receive $180,000 back later, or is it better to pay only $260,000 up front and potentially receive nothing after the amortization period ends, aside from any refund that might apply during the initial declining-balance window?
The better choice depends on the time horizon and a set of financial assumptions. There is a break-even point: before that point a refundable contract may be preferable, while after it the traditional contract could be the better deal. Identifying the break-even timeframe and the assumptions behind it helps clarify which option is likely to suit an individual’s situation.
How to find the true net cost of each option
Traditional contract
In today’s dollars the outlay for the traditional contract is $260,000. To calculate the true net cost, however, you must consider the opportunity to invest the $100,000 difference between the traditional and refundable options. That invested amount may grow over time, effectively reducing the net cost of the traditional contract.
For example, using a 10-year time frame and a hypothetical 4 percent average annual return on the $100,000 the resident keeps, the investment would grow by about $48,000 over ten years. Discounted back to present value using a sample inflation rate, the present value of that $48,000 in 10 years is roughly $36,000. Subtracting that present value from the $260,000 outlay gives a true net cost near $224,000 over a 10-year period.
Refundable contract
The refundable contract’s net cost is the initial $360,000 minus the present value of the refundable amount. Using the same 10-year horizon, the present value of a $180,000 refund received in 10 years would be roughly $134,000 under the example assumptions. That yields a true net cost for the refundable contract of about $226,000 ($360,000 minus $134,000) over ten years.
The bottom line on refundable entry fees
In this illustration the difference between the two options is only about $2,000 over ten years, indicating the break-even point is near that timeframe. After the break-even point, the traditional contract would generally be the better financial choice. However, this conclusion depends heavily on the assumptions used—time horizon, inflation or discount rate, rate of return on invested funds, and exact contract terms and pricing. Changing any of those factors can change which option is more advantageous.
* Example uses a hypothetical inflation/discount rate of 3 percent