Retirees face a variety of risks: bear markets, inflation, uncertain lifespan and declining health and the associated costs. Among these, health and health-care costs are the top concern for the majority of retirees, according to a recent T. Rowe Price study of retirement savings and spending.
This should not come as a surprise to financial advisers and their clients, considering some of the industry's leading experts are projecting very high health-care costs in retirement.
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The Employee Benefit Research Institute estimates a 65-year-old couple will need to budget approximately $301,000 to have a 90% chance of covering all their health insurance premiums and out-of-pocket costs, excluding long-term care, in retirement. Other estimates provide a similar picture.
While these numbers have some informational value, they aren't helpful for financial planning because:
• The cost of health care in retirement isn't a lump-sum bill, but one that is paid over 20 to 30 years. We might balk at an $86,000 cable bill in retirement, but that's what a $150 monthly cable bill adjusted for inflation adds up to over 30 years (assuming 3% annual inflation).
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• It's difficult to fathom the relative magnitude of health-care costs when they're measured in current dollars, but not in terms of assets and future stream of income. For example, a 65-year-old couple with $400,000 in retirement savings and $2,000 in combined monthly Social Security income might panic if they think they will need $300,000 for health-care alone in retirement. Those expenses might seem more manageable if they knew that that their future Social Security benefits and asset income added up to about $1.3 million in current dollars. (With a 2% cost-of-living adjustment, the present discounted value of their Social Security benefits is about $583,000 over the next 20 years and a 4% nominal return produces another $320,000 in income.)
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• Most estimates assume a single type of health insurance coverage, yet there are many options with different cost implications. According to the Kaiser Family Foundation, 30% of all traditional Medicare beneficiaries in 2016 had supplemental coverage through employer-sponsored insurance, 29% had supplemental Medigap coverage and 19% had no supplemental coverage at all. Also, one in three of all Medicare beneficiaries were enrolled in a Medicare Advantage plan in 2018.
So how should retirees estimate their health-care costs? We recommend considering:
1. The annual costs
2. The type of insurance coverage
3. Separating premiums and out-of-pocket costs
Note: For individuals ages 65 and above. Includes traditional Medicare (Parts A and B) and prescription drug plan (Part D). All costs are rounded to the nearest hundred.
Source: T. Rowe Price estimates based on projected 2019 Medicare premiums and data from the Health and Retirement Study public use dataset. Produced and distributed by the University of Michigan with funding from the National Institute on Aging.
The chart above provides an example of how these costs look in retirement. In looking at this and other types of health insurance coverage, a couple of things stood out:
• In all cases, premiums account for nearly 75%-80% of annual health-care costs.
• Even though out-of-pocket costs are small on average, they can vary a lot.
How should advisers use this information?
• Premiums should be budgeted and paid for from monthly income because they are usually fixed and the annual premium changes are mostly predictable.
• Because out-of-pocket costs vary, they should be paid from relatively liquid assets, like a savings account.
Don't fixate on one large number when it comes to health-care costs. To a large extent, they can be planned for and managed.
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Sudipto Banerjee is a senior manager of thought leadership at T. Rowe Price.
