Health-care costs are the great unknown of retirement.
Not only are health expenses rising quickly overall, but medical needs and conditions vary dramatically from person to person. There are several moving parts, from combinations of different health-insurance packages to decisions around long-term-care coverage.
As Americans live longer —some well into their 90s and 100s — health care, already a top expense for most retirees, promises to become an even more prominent item in their budgets.
Indeed, future health costs are the portion of a client's retirement-income plan that's most unpredictable, according to Thomas West, partner at Signature Estate & Investment Advisors.
“Planners and retirees are faced with uncertainties about mortality and morbidity, and projections just a few years into the future can feel only a little better than a wet finger in a breeze,” said Mr. West, who specializes in financial planning for ill and disabled clients.
However, there are approaches advisers can use to tame the health-care beast, and determine realistic estimates to set clients up for a higher probability of success.
Part of advisers' confusion — and investors' fear — comes from headline numbers on conflicting estimates of the amount of money needed to cover retiree medical costs.
Fidelity Investments, for example, estimates a 65-year-old couple retiring this year will need an average $260,000 to cover health costs in retirement, and an additional $130,000 for long-term-care insurance.
The Employee Benefit Research Institute cuts its data more granularly. In 2015, a 65-year-old couple with median drug expenses would need a total of $158,000 to have a 50% chance of covering medical expenses, the think tank says.
However, a couple with high prescription-drug expenses (90th percentile) would need $392,000 — around $230,000 more — to have a 90% chance of covering costs.
HealthView Services, which produces health cost-projection software, estimates a $288,400 need for 65-year-old couples, which swells to $377,412 when out-of-pocket expenses, such as deductibles, co-pays, hearing, vision and dental, are included along with Medicare and supplemental insurance premiums.
Obviously, there are discrepancies in how each group calculates and presents the data, but these figures all point to one general theme: Health care is expensive and the cost can be widely variable.
Out-of-pocket costs not covered by insurance can easily sink an otherwise buoyant ship if not planned for accordingly.
“The good news is Medicare picks up a lot of [the cost],” said David Edwards, president of Heron Financial Group. “But there are always little extras on the side, and you can't estimate what those are going to be because everyone's health is going to be different.”
Medicare, the federal health-insurance program for Americans aged 65 and older, covered 60% of health expenses incurred by seniors in 2012, according to EBRI's most recent annual report.
Private insurance such as Medigap plans that help pay for costs not covered by Medicare accounted for 15%. Out-of-pocket costs such as co-payments, co-insurance and deductibles (which would be covered, at least in part, by a Medigap plan) represented 13%.
“What often gets overlooked is vision and dental,” said Scott Hanson, co-founder and co-CEO of Hanson McClain Advisors. Some clients have spent $20,000 a year just on their teeth, he said.
Some advisers, such as Neela Hummel, chief planning officer at Abacus Wealth Partners, try to minimize planning — and guesswork — for out-of-pocket costs by concentrating on insurance premiums.
It's more predictable for advisers to look at how much a client's insurance premiums are today and provide a reasonable assumption for future costs based on historical rates of inflation, than attempt to project costs based on how many times a client will go to the doctor or need prescription drugs, said Paul Fronstin, director of EBRI's health research and education program.
For Medicare-eligible clients, Ms. Hummel factors in premiums for Medicare Part B and Part D (for medical services, such as doctor visits, and prescription-drug coverage, respectively) and the “most comprehensive” supplemental plan, Medigap Plan F. She also factors in some out-of-pocket expense.
When projecting costs for preretirees, she generally assumes a total of $300 per month per person for individuals with income less than $170,000 (married filing jointly) and $600 per month for those in higher-income brackets, because Medicare premiums are based on income. Ms. Hummel doubles these estimates for a standard two-person couple.
Mr. Edwards of Heron Financial said most of his clients have Medigap insurance, which will cover the majority of health costs Medicare doesn't cover. To better ensure clients can cover future health costs, he tries to achieve full income replacement for them in retirement (rather than the 70% or 80% figure that's often touted). Rather than spend less in their retirement years, clients tend to shift the spending mix from children, clothing and cars, for example, to health care and travel.
“In general, if you provide 100% coverage of income in retirement, you're going to be OK,” he said.
Of course, there are drawbacks to maximizing insurance coverage. Premiums could end up being higher than an individual would pay out of pocket, Mr. Fronstin said, so advisers need to weigh these pros and cons with clients.
(Related read: Health savings account limits to increase for some in 2017)
Some clients may prefer using Medicare Advantage plans, for example, which can potentially be more cost-effective than the traditional Medicare-Medigap route but often offer smaller networks of medical professionals, according to Sunit Patel, senior vice president of Fidelity's benefits consulting group. Medicare Advantage plans are offered by private companies that contract with Medicare.
Pearce Landry-Wegener, a wealth management adviser at Summit Place Financial Advisors, said most of his clients, who have assets of at least $5 million, don't bother with Medigap coverage. The most important consideration for these high-net-worth individuals is how major medical conditions such as cancer or Parkinson's disease could severely crimp a portfolio, he said.
Mr. Landry-Wegener analyzes five-year windows — ages 70-75 and 80-85, for example — in which clients spend $50,000 per year (so, $250,000 over the five-year time frame) on medical expenses, and how that drawdown would affect future cash flow. (In his experience, $50,000 is what clients spend toward these costs on average.)
PLAN TO 100
Several advisers, such as Mr. Landry-Wegener and Carolyn McClanahan, director of financial planning at Life Planning Partners Inc., use a default longevity of 100 years old when modeling financial plans. However, major medical issues and family health history could revise that downward.
“An overweight, insulin-dependent diabetic in his 60s is not likely to live close to his life expectancy and likely won't rack up decades of health-care bills,” said Mr. West of Signature Estate & Investment Advisors.
Conversely, a fit, active 80-year-old is very likely to live well beyond his or her expected span and face years of expensive long-term-care costs, he said.
“It's egregious to plan for someone to live to 100 when they're unhealthy and will probably live to 70 or 80,” Ms. McClanahan said.
She asks about clients' “health mindset” to determine if they're health-care “maximizers,” who go to the doctor for everything, or “minimizers,” who do so only when absolutely necessary.
Ms. McClanahan gives regular presentations to advisers on health care as it relates to financial planning, and developed a four-quadrant grid to provide rough estimates for health costs.
The grid sets out approximate expenses for different levels of health and the frequency of health-care use, and is based on numbers from EBRI's recent health-cost analysis.
Because EBRI's numbers are based on the age of death used in actuarial tables, Ms. McClanahan said figures should be extrapolated when planning to age 100.
(Related read: Health savings account limits to increase for some in 2017)
Ultimately, though, trying to be precise with projections 30 to 50 years off isn't anchored in reality, because it never works as planned, she said.
But “if you want to plan for health-care costs, at least try to be more refined so you don't give people a heart attack over the numbers,” Ms. McClanahan said.
Of course, long-term-care expenses have the potential to throw a wrench into financial plans if not taken into account properly.
According to the American Association for Long-Term Care Insurance, the average stay for a man or woman in a nursing home is between two and three years. That has the potential to cost a client hundreds of thousands of dollars.
For example, a Connecticut resident needing long-term care would spend approximately $60,000 per year for an assisted living facility, and $160,000 for a private room in a nursing home, according to an online state-by-state cost-comparison service from Genworth Financial Inc., the largest LTC insurance provider.
When modeling LTC costs, Ms. Hummel starts by asking whether a client would prefer 24-hour in-home help, an assisted living facility or nursing home should an LTC need arise.
If a client doesn't want to self-insure for eventual LTC costs by using assets from an investment portfolio or home equity, Ms. Hummel will model out LTC insurance premiums, a task that's become increasingly difficult as insurers have raised premiums on in-force policies.
She'll discuss worst-case scenarios before modeling costs, because client sentiment could affect the plan either way. For example, a client with a $6 million home who'd be comfortable downsizing to a $2 million home in the event a spouse needed long-term care would effectively free up $4 million to cover LTC costs.
Ultimately, the best advice for advisers with respect to health costs is to “plan for a best-case and a worst-case, health-care-cost scenario,” Mr. West said.