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Robert Powell

April 10, 2021, 4:01 p.m. EDT

How to pay for healthcare costs in retirement

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Robert Powell

As retirement risks go, it’s one of the more impossible to manage and mitigate.

Or is it?

For years now, firms in the financial services industry, as well as researchers, have been scaring preretirees into thinking they need an ungodly amount of money set aside at age 65 to pay for years of healthcare costs in retirement.

Fidelity Investments, for instance, estimated that the average 65-year-old couple would need $295,000 in 2020 dollars for medical expenses in retirement, excluding long-term care

And the Employee Benefit Research Institute estimated a couple retiring in 2020 with drug expenses at the 90th percentile throughout retirement who wants a 90% chance of having enough money for healthcare expenses in retirement by age 65 should earmark $325,000. 

It’s true that healthcare is not an easy risk for which to plan. 

“Healthcare is perhaps one of the hardest risks to plan for in retirement,” said David Blanchett, head of retirement research for Morningstar’s Investment Management.  

But lately, researchers are pushing back on the notion that you’ll need what in effect is more than what the average 65-year-old has socked away for all their retirement expenses. (For the record, the median retirement savings of Americans in their 60s was $172,000 according to a Transamerica Center for Retirement Studies survey, and the median net worth — assets minus liabilities — for people ages 65-74 was $266,400, according to the Survey of Consumer Finances.)

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In short, experts say preretirees need to think about healthcare costs as an annual expense that’s broken down into easy-to-predict premiums and less easy-to-predict out-of-pocket expenses, and then revisit the odds, the real odds, of having late-in-life shocks and long-term care expenses. 

“I think there is a lot of focus on the big, scary numbers without a good understanding of who or how many retirees are likely to spend such large sums,” said Sudipto Banerjee, vice president of retirement thought leadership at T. Rowe Price. “A few retirees spend a lot on healthcare for sure, but most don’t. Focusing only on the large numbers creates a distorted picture of healthcare costs and creates fear among retirees. I think part of this fear is manifested in underspending in retirement.”

Also, while there is a lot of discussion about healthcare costs, there is relatively less discussion on how to plan for them, he said. “Most planning discussions focus on long-term-care insurance, and understandably so. But the choice of different types of Medicare plans — traditional, Medicare Advantage, Medigap etc. — and drug plans — Part D — might also have a large impact as well.”

View healthcare costs as an annual expense

According to Banerjee, viewing retirement healthcare costs as an annual expense, instead of as a lump sum, makes it easier for retirees to plan for and pay for them. 

Lump-sum estimates are not useful for planning because healthcare costs are not incurred as lump-sums. 

“Even if a 65-year-old couple knows with certainty they will need $400,000 for healthcare costs, they don’t know how much of that is needed when they are 65, 75 or 85,” Banerjee said. “This makes planning difficult.”

Read A New Way to Calculate Retirement Health Care Costs .

So how much should you expect to pay for healthcare expenses each year? 

Well, the estimates from different sources vary, but only slightly.

Banerjee estimates annual healthcare expenses at the 50th percentile at $5,200 for those covered by traditional Medicare (Parts A and B) and a prescription drug plan (Part D); at $4,500 for those covered by a Medicare Advantage HMO plan that includes prescription drug coverage (MA-PD plans); and at $7,900 for those covered by traditional Medicare (Parts A and B), a prescription drug plan (Part D), and Medigap.

According to a paper published in the Retirement Management Journal (an academic journal at which I serve as editor), the average annual healthcare expenses for all retirees ages 65-94, excluding long-term costs, are roughly $4,500, or 15% of total spending.

Read Understanding the True Cost of Health Care in Retirement by Nick Halen, Kelli Faust, and Todd Taylor.

Vanguard predicted the annual healthcare expense of a 65-year-old woman in 2018 was $5,200. Read Planning for healthcare costs in retirement .

And Fidelity says the average 65-year-old couple will spend around $11,400 on healthcare in the first year of retirement. 

So, there you have it: the average person will spend around $5,700 in today’s a year for premiums and out-of-pocket expenses. 

Breaking down healthcare costs into categories: premiums and out-of-pocket (OOP) costs, deductibles, copayments, coinsurance, services not covered through insurance; can also reduce the anxiety often caused by looking at the lump-sum amounts required to pay for healthcare costs in retirement. 

According to the Retirement Management Journal paper, costs can be broken down into premiums that account for 64% of total healthcare spending across all retirees and “likely will be known in advance with a relatively high degree of certainty” while out-of-pocket costs — which account for 36% of total healthcare spending — are truly variable and more difficult to predict. 

Most healthcare costs can be planned for through proper planning

Banerjee’s research provides a slightly different but similar assessment. “Health insurance premiums account for roughly 75%-80% of annual healthcare expenses,” he noted. “And these can be budgeted and planned for like any other recurring household expenditure item. This means most healthcare costs can be planned through proper retirement income planning.”

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