Planning for Health Care Costs in Retirement

According to the Employee Benefit Research Institute’s 2016 Retirement Confidence Survey, just 27% of workers and 37% of retirees have estimated how much they would likely need for retirement health expenses.  This is somewhat surprising given the level of concern that many people (rightfully) have when it comes to future health costs.  In fact, several recent surveys indicate that health care costs are at or near the top of the list of retirement concerns. As a financial planner, it is challenging to help clients wrap their minds around the impact that health care expenses will have on their retirement.   While certain aspects of health care’s impact on your finances are out of your control (e.g., illness related to your genetics, the rising cost of care, etc.) my hope is to at least arm you with a little knowledge that may help you better plan for what you can control.

Health Care Costs in Retirement Can Vary Greatly

I want to start by pointing out the obvious, health care costs are highly variable, which is why they are so hard to predict.  Your age, health status, gender, state of residence and income level can all have a big impact on the costs you will face.  The data I discuss will be helpful as a starting point but your personal situation will ultimately dictate what costs you will face.  It’s important to note that just being healthy won’t likely drive down your costs.  As a matter of fact, longevity is perhaps the biggest driver of your total costs and the longer you live the longer you will be a consumer of health care.  Further, your income in retirement will also have an impact as the cost of certain parts of Medicare increase if your income rises.

Medicare Won’t Cover Everything

Before we get into actual dollar figures, let’s make sure you have a basic understanding of what types of costs you might incur and what portions of those costs you will need to cover out-of-pocket.  Starting at age 65 Medicare will cover certain of your basic health care related expenses.  But Medicare isn’t free and it will not cover all of your expenses (most notably, it will not cover long-term care).  In fact, HealthView Services estimates that Medicare covers only 51% of total health care expenses in retirement.[i]

You will pay premiums each year for Medicare Part B (medical visits and tests) and also potentially Part D (prescription drug), Medicare supplement insurance (which covers some of what Medicare doesn’t) and Medicare surcharges (depending on your income level).  For couples whose Modified Adjusted Gross Income (MAGI, discussed more below) is more than $170,000 in retirement ($85,000 for individuals), Medicare surcharges can raise costs on Parts B and D anywhere from 35% to over 200%!  You will also face other out-of-pocket costs that include co-payments, deductibles and other drug and medical costs (including hearing, dental and vision costs).  These out-of-pocket costs typically accelerate with age.  For more information on what Medicare covers (and doesn’t cover), you can visit https://www.medicare.gov/.

Estimating Health Care Costs in Retirement

So how much will all of this cost you?  In a recent Barrons’ article[ii], HealthView Services estimated the health care costs for a high-income (MAGI of $250,000), healthy 65 year old couple (with the man living to age 87 and the woman living to age 89) at a combined $565,142 (discounted back to today’s dollars).  Keep in mind this amount does not include any costs you might incur for long-term care expenses (discussed further below).  To put this in better perspective, those numbers equate to $15,417 annually per couple in today’s dollars and are then inflated higher each year going forward.

If you end up facing a chronic condition such as diabetes, cancer, Parkinson’s, arthritis, high blood pressure, osteoporosis, pulmonary disease, etc. you will face higher annual expenses (though your lifetime expenses may actually be lower due to a lower life expectancy).  For example, HealthView Services estimates the health care costs for a high-income, diabetic 65 year old couple (with the man living to age 78 and the woman living to age 81) at a combined $343,819 (discounted back to today’s dollars and again not including long-term care).  Those numbers equate to $17,054 annually per couple in today’s dollars and inflate up from there each year.

There are obviously other groups out there that have made their own estimates on what these costs may look like. These projections can vary widely based on the underlying assumptions used in the study.  Perhaps the most important variable to consider (other than estimating your life expectancy) is the percentage used to inflate health care expenses each year.  A range of 5% to 6% is typically used, but in all cases these costs are outpacing inflation on other types of spending.

Separating Out Potential Long-Term Care Costs

Perhaps the biggest wildcard in all of this is the potential cost of long-term care in retirement.  These are expenses for things such as in-home care or staying in an assisted-living facility or nursing home.  These costs can vary widely depending on the type of care, geographic location, quality of facility and length of stay.  While not everyone will incur costs related to long-term care, several estimates show that about 7 out of 10 of those reaching age 65 will.  We suggest getting estimated costs for long-term care facilities in your area for purposes of projecting out potential future costs.  For example, in Omaha, NE the 2016 median cost per year was $79,023 for a private room in a nursing home, $48,000 for an assisted living facility and $52,624 for in-home care.[iii]

A common scenario that plays out is that one spouse will care for the other and the survivor will then be the one who requires long-term care assistance in some manner.  Often the woman cares for the man since women tend to live longer.  We typically model out a scenario where we have long-term care expenses come into the picture for one member of the couple around age 85 and for a period of 3 years (which is considered an average length of stay although that can obviously vary if Alzheimer’s or some other condition comes into play).  By modeling out different scenarios we help our clients determine if they are in a position to self-fund for potential long-term care expenses or whether they need to look into insuring against that risk.

Health Savings Accounts

As you try to incorporate this data into your planning, one savings vehicle that may be available to you but that is often overlooked is the health savings account (“HSA”).  HSA’s are a savings account for health and medical expenses and they receive preferential tax treatment.  Contributions to HSA’s are pre-tax, the value in the account grows tax-deferred and withdrawals are tax-free if used for qualified medical expenses.  Non-qualified withdrawals are taxable as ordinary income plus a 20% penalty tax, but that penalty is waived for those over age 65 and certain other exceptions.  Contribution limits for HSA’s are currently set at $3,350 per year for an individual and $6,750 for a family, with a $1,000 catch-up provision for those over age 55.  To be eligible to contribute to an HSA you must be covered under a High-Deductible Health Plan and not be enrolled in Medicare or other health coverage.  The potential triple-tax advantages of HSA’s can be a very powerful tool and should be evaluated alongside your other savings vehicles to find the best balance for your situation.  For more information on HSA’s, check out a recent post by one of our Lutz CPA’s, Kelly Martinson, which can be found here:  https://www.lutz.us/maximizing-hsa-contributions/.

Manage Your MAGI in Retirement to Minimize Your Medicare Surcharges

Due to the potential Medicare surcharges you could face based on your MAGI in retirement, consideration should be given to ways to mitigate that risk.  For example, distributions taken from a Roth IRA or Roth 401k are not included in the calculation of your MAGI so increasing your Roth contributions before retirement would be one approach.  Similarly, evaluating a Roth conversion in the early years of retirement, particularly in the years prior to starting Social Security and before required minimum distributions kick in, could make a lot of sense as well.  Keep in mind that distributions from HSA accounts generally don’t increase your MAGI either.

Start Planning Now

The main take away I hope you get from reading this is the importance of factoring in these potential costs as you plan for retirement.  We always suggest that people run a retirement cash flow analysis as a part of their comprehensive financial plan.  As you do this analysis, it is important to take into account the impact that health care costs and long-term care costs could have on your retirement nest egg.  Make sure you are using reasonable assumptions and planning software that has the functionality and sophistication to model out different scenarios in a comprehensive manner.  The software we use allows us to break out health care costs and long-term care costs and show our clients their potential impact based on different cost estimates, inflation rates and other varied assumptions tailored to their particular situation.

Also included with any comprehensive financial plan should be advice on how best to allocate your savings among the different types of savings vehicles available.  These vehicles typically include the retirement plans available at your work (401k’s, 403b’s, etc.), IRAs, HSA’s (if available to you) and regular taxable investment accounts, amongst others.  Make sure you are appropriately leveraging the tax-favored accounts you have available to build up your retirement nest egg so it can grow to cover your future needs.

Control What You Can

The rising cost of health care and long-term care and their potential impact on your retirement may seem overwhelming.  The important thing is to focus on what you can control.  The first step is understanding what those future costs may be and how to properly factor them into your comprehensive financial plan.  If you haven’t already, start a discussion of these issues with your financial planner and put a game plan in place.

[i] http://www.hvsfinancial.com/PublicFiles/Closing_The_Gap.pdf

[ii] http://www.barrons.com/articles/the-real-cost-of-health-care-in-retirement-1486186876

[iii] https://www.genworth.com/about-us/industry-expertise/cost-of-care.html

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