As a financial planner I am often asked how to estimate what health-care costs will be in retirement.
Also, some of my clients want to retire before becoming eligible for Medicare at age 65, so covering the cost of health care during the gap before Medicare is critical.
A recent study by Fidelity Investments estimated that a 65-year-old couple may spend $295,000 on health-care costs in retirement. However, don’t let the lump sum scare you. No one needs a lump sum for medical expenses at retirement, because the estimate is based upon living a full life. Fidelity’s study was based on actuarial tables, which suggest women live to 86 and men to 85, so the $295,000 works out to approximately $14,048 per year per couple.
In an October 2018 online article titled “Getting Real about Annual Health Care Costs in Retirement,” Michael Kitces emphasizes the need to plan for medical expenses on an annual basis rather than as a lump sum. As a comparison, he states that the lump sum value of the average $1,294 per month Social Security benefit equates to roughly $280,000 for men and $335,000 for women over their lifetime. Yet, we do not think in terms of lump sums for Social Security.
What makes up the estimated $14,000 in annual health-care expenses per couple? According to Kimberly Lankford in an article in US News and World Report, roughly 40% of the expenses (in the Fidelity study) are for Medicare premiums, 40% for Medicare co-payments and deductibles, and 20% for prescription drugs.
Coverage components
Medicare Part A covers inpatient hospital stays. It is free for people who have accumulated the qualified 40 quarters ( ¼ year) of contributions to Social Security, and it is discounted if someone has between 30 and 40 quarters.
Part B is medical insurance for doctor’s services on an inpatient or outpatient basis. The base charge in 2020 is $144.60 per month. However, there is a surcharge called Income-Related Monthly Adjustment Amount (IRMAA), which is based on the “modified adjusted gross income” (MAGI) from your tax return. This surcharge can cause the monthly premium to go as high as $491.60 for a single person with MAGI of $500,000 or a married couple filing jointly with MAGI of $750,000 or above.
Part C is a private plan, often called a supplemental plan. It can also be a Medicare Advantage plan. Premiums vary, depending on the plan chosen.
Part D is a prescription drug plan. Premiums vary according to the plan chosen, and co-pays and coverage also vary. Part D premiums are also subject to the IRMAA surcharge based on income.
The annual estimate of $14,000 per couple typically does not cover dental care, eye care, long-term care costs in a facility, or home health care.
Keep in mind that the $14,000 is only an estimate, and the expense will vary widely. A client who recently went onto Medicare at age 65 shared his figures with me. The basic Medicare Parts B, C and D will cost him $4,164 per year. However, due to his high income, he is triggering the IRMAA surcharge for Parts B and D, so his actual cost will be $8,821 per year. These figures are only for one person, so this would be almost $18,000 for a couple. These figures also do not include any co-pays or deductibles, so the cost for a couple could easily reach $20,000.
Budgeting health care
Where does this leave us in terms of estimating health-care costs in retirement? I recommend that my clients estimate how much they will spend for their basic living expenses, then add a separate line item for health care. Let’s assume a couple estimates their living expenses may total $6,000 per month, or $72,000 per year. We then add an estimate for health care ($14,000), for a total of $86,000 per year. Depending on the clients’ lifestyle, we may add a separate annual budget for travel and home maintenance. A replacement car is included in the year it is expected to be needed, and expenses such as major dental work may be added. Obviously, each couple has different saving and spending habits, so this is only an example.
Retirement planning software is needed to wrap up the plan with a bow. If you work with a financial adviser, ask them to help you prepare retirement projections every year. If you do not have a financial adviser, there are programs available at Vanguard and Fidelity, or search online under “free retirement planning software” for other choices.
Now, what about the couple who wants to retire early and needs to buy health-care insurance prior to age 65? This is a moving target that changes each year, based on the Affordable Care Act and private insurance options. COBRA from a prior employer may be available, but it is expensive. In this case, the couple needs to do research to see what is available in the state where they live. For retirement projections, I recommend estimates as high as $10,000 per person a year, or $20,000 per couple. Once they reach age 65 they can lower their estimate to the current annual expense (which is now $14,000 per year per couple).
Going lower
Now that you know how much you can anticipate spending on health care, how can you lower those costs? A 2018 joint study between Vanguard and Mercer Health and Benefits looked at factors that impact health-care expenses during retirement. One factor, which is often overlooked, is how healthy we are. The joint Vanguard/Mercer study suggests an individual’s underlying chronic conditions impact the amount spent on health care as well as how long a person will live. Specifically, chronic conditions such as “hypertension, high cholesterol, arthritis, heart disease, diabetes, kidney disease, depression, Alzheimer’s and dementia, chronic obstructive pulmonary disease (COPD), cancer, asthma, and osteoporosis” are major factors influencing a person’s health-care costs. Many of these conditions can be avoided by living a healthy lifestyle, such as eating nutritious food, exercising and maintaining a healthy weight.
It is encouraging to know that improving your lifestyle can significantly impact how much you spend for health care during retirement. It may allow you to spend a part of your $14,000 annual budget on traveling and other experiences rather than on health care!