A new report projecting health care costs for current and future retirees is chock full of scary numbers that should keep most financial planners up at night. But just as hiding under the covers during graphic horror flick scenes won't change the ending, ignoring hard-to-calculate health care costs won't improve the outcome of your clients' retirement plans either.
The HealthView Services 2016 Retirement Health Care Costs Data Report also challenges traditional planning methods of using income replacement ratios (IRR) to determine how much clients will need to maintain their living standards in retirement. Without factoring in realistic health care costs and appropriate health care inflation, your clients could be under saving for their real retirement income needs.
And those health care costs could be eye popping.
HealthView Services' data shows the average healthy 65-year-old couple retiring this year is projected to spend $288,400 in today's dollars on lifetime Medicare Parts B, D and supplemental insurance premiums. When typical out-of-pocket costs for services not covered by Medicare, such as vision, dental and hearing are included, the couple's total retirement health care bill rises to $377,412 — $33,000 more than a similar age couple who retired last year.
Younger clients could face even higher medical bills over their lifetimes. A 55-year-old couple is likely to rack up total retirement health care costs of nearly $466,000 in today's dollars and a 45-year-old couple could expect to pay more than $592,000.
All calculations assume average life expectancies of 87 for men and 89 for women. HealthView Services, which produces health care cost-projection software for financial advisers and financial institutions, expects health care inflation to average 5.1% annually over the next 20 years, well ahead of the general inflation rate that has been running at less than 1%. The health care cost projections do not include long-term care expenses.
Given their longer average life expectancies coupled with the effects of a compounding inflation rate, women will spend more than males on retirement health care on average. And although it may seem counterintuitive, healthy clients may have higher lifetime medical bills than those with a chronic disease, such as diabetes, due to the disease's impact on life expectancies.
(Related editorial: Advisers' role in retiree health care)
“Few Americans have taken steps toward addressing medical expenses in retirement and most do not understand Medicare costs,” said Ron Mastrogiovanni, founder and CEO of HealthView Services. But with the right mix of investment products, additional contributions to existing retirement plans or health savings accounts and an adequate time horizon, many Americans will be able to pay for their health care costs in retirement, he said.
OUTPACING SOCIAL SECURITY BENEFITS
Health care inflation is expected to outpace Social Security cost-of-living adjustments for the foreseeable future. Over time, medical costs may eventually exceed gross Social Security payments.
In 2016, the average 66-year-old couple will need 57% of their lifetime pre-tax Social Security benefits to pay for health care costs. A 55-year-old couple will need 88% and a 45-year-old couple, 116%, the report said.
Higher-income seniors pay more for Medicare Part B, which covers doctors' visits and outpatient services, and Medicare Part D, which pays for prescription drugs, if their annual income exceeds $85,000 if they are single or $170,000 if they are married. There are five income brackets with additional surcharges ranging from 37% to 205% of basic monthly premiums.
Although only about 5% of retirees currently pay higher Medicare premiums, more people will pay higher rates in the future.
Starting in 2018, the top three income brackets will be revised downward so that affluent retirees will be placed into higher brackets than today. In 2018, the top bracket for singles will be reduced to $160,000 a year, down from $214,000 today, and the top bracket for married couples will be trimmed to $320,000 per year, down from $420,000.
Medicare premium surcharges are based on the latest available tax return so the higher Medicare premium surcharges in 2018 will use information from 2016 tax returns that are filed in 2017. Modified adjusted gross income (MAGI) includes earnings, Social Security benefits, tax-deferred pension, required minimum distributions, capital gains and interest that is normally tax-free. Distributions from Roth IRAs and Roth 401(k)s, health savings accounts, life insurance and reverse mortgages do not count in the MAGI calculation.
Because the income levels are not indexed to inflation, many middle-class retirees may eventually fall into upper MAGI brackets and face even higher surcharges as salaries grow over time. Medicare means testing is expected to affect 25% of all Medicare beneficiaries by 2036, according to a 2014 report from the Urban Institute for the Kaiser Family Foundation.
(Questions about new Social Security rules? Find the answers in my new ebook.)
Mary Beth Franklin is a contributing editor to InvestmentNews and a certified financial planner.