Even the strongest retirement plans can be derailed by health care costs

Rising health care costs have long been the bane of working Americans, but most people don’t give enough thought to how escalating health care costs in retirement can derail even the most solid financial plan.

“While the exact cost varies for each individual, most people should expect health care to be their second-highest expense in retirement, trailing only housing,” said Angie O’Leary, head of wealth planning at Minneapolis-based RBC Wealth Management-U.S. “Even a healthy 65-year-old couple today can expect to spend more than $400,000 on health care in retirement.”

To help investors and advisers plan ahead, RBC Wealth Management created “Taking Control of Health Care in Retirement,” a new guide to understanding and managing the many components of care for aging Americans. It includes information and tools to help investors and advisers estimate how much individuals can expect to pay for health care once they retire based on their anticipated life expectancy, overall health and gender.

The guide includes actionable steps such as using health savings accounts and Roth IRAs to create future tax-free income that can reduce not only income taxes in retirement, but how much some retirees will pay for Medicare. Medicare imposes monthly surcharges on individuals whose income exceeds $85,000 and married couples whose combined income exceeds $170,000. Medicare premium surcharges in 2018 are based on income reported on 2016 tax returns.

Speaking of Medicare, costs continue to rise for higher-income retirees. New income tiers took effect this year that boost monthly premiums for Medicare Part B, which covers outpatient services, and Medicare Part D prescription drug plans in 2018. The new tier affects individuals whose MAGI topped $133,500 in 2016 and for married couples whose MAGI exceeded $267,000. They now pay $348.30 per month for Medicare Part B in compared to the standard monthly premium of $134.

Next year, a new top income tier will be added to the Income-Related Monthly Adjustment Amount (IRMAA) surcharges that will affect individuals whose MAGI exceeded $500,000 in 2017 and married couples whose MAGI exceeded $750,000 in 2017. The latest Medicare premium surcharge was included in the two-year budget agreement that President Trump signed into law earlier this month. Retirees in the new top income tier will pay more than $450 per month, per person, for Medicare Part B in 2019, plus surcharges for Medicare Part D. In addition, most people who opt for traditional Medicare, rather than all-inclusive Medicare Advantage plans, also purchase private supplemental Medigap plans to cover Medicare’s deductibles and co-payments.

Investors aren’t entirely oblivious to the challenge of paying for health care in retirement. In fact, 80% of the more than 1,000 American adults surveyed by Ipsos on behalf of RBC Wealth Management say they are worried about funding the costs of health care as they age. Despite those concerns, only 56% of survey respondents said they have factored health care into their retirement plan.

Half of those who indicated they have planned for health care costs admit that they have probably underestimated those expenses. Investors in the survey expect to pay about $2,700 per year, on average, in out-of-pocket health care costs. In reality, experts estimate that at age 65, annual spending on health care is close to $16,000 per person.

“Understanding how you will fund health care as you age is one of the most important steps you can take in the wealth planning process,” Ms. O’Leary said. “But because it is such a complex thing to plan for and can be so emotionally charged, most people put off thinking about it until it is too late.”

It is time for financial advisers to step up to the challenge of including health care estimates in retirement income plans.

The “Taking Control of Health Care in Retirement” guide recommends making health care expenses a separate category in a retirement income plan, using an annual inflation rate of at least 5%. But even that may be too conservative.

National health spending growth is expected to average 5.5% annually from 2017 to 2016, according to a new report published by the Office of the Actuary of the Centers for Medicare & Medicaid Services. The projected growth is fueled by both economic and demographic trends as aging baby boomers transition from private health insurance to Medicare and accelerate the use of expensive medical procedures such as joint replacements and cataract surgery.

“Among the major payers for healthcare over the 2017-2016 period, Medicare is projected to experience the most rapid annual growth at 7.4%, largely driven by enrollment growth,” the CMS report said. That compares with projected growth in private health insurance costs of 4.7% annually.

Prescription drugs are the fastest-growing category in health care spending, projected to rise by 6.3% a year from 2017 to 2026, in part as a result of increasing prices for specialty drugs.