When estimating how much they'll spend in retirement, most people focus on monthly bills: Food. Gas. Utilities. Housing. But they often fail to price in health care costs.
And not minding health care costs in retirement is a potentially costly oversight. Medical costs are one of the largest expenses in retirement. And they've been rising faster than the overall inflation rate for years. One major illness can often be enough to crack your nest egg.
Talk about sticker shock. An average retired couple who were 65 in 2021 may need $300,000 saved (after tax) to cover health care expenses in retirement, according to Fidelity Investments. It's no surprise that 80% of respondents to an RBC Wealth Management survey said they're "concerned about funding the cost of care." No wonder nearly half of Americans worry about how to plan for health care costs in retirement, says an IBD/TIPP poll based on surveys in early April.
"This is a fixed cost you will have for the rest of your life," said Bruce Maier, financial advisor at Ameriprise Financial.
Know How Health Care Costs Change
Still, you don't have to make yourself sick with worry over these scary projections. You don't, for example, have to pay for 20 or 30 years of health insurance premiums, deductibles, and copays, in one lump sum, says Paul Fronstin, director of health benefits research at the Employee Benefit Research Institute (EBRI).
Typically, health care expenditures rise as you age. A healthy couple between 65 and 74, for example, will spend $12,000, on average, each year for health care, according to RBC Wealth Management. But that annual cost rises to $21,000 between the ages of 75 and 84, and spikes to $38,000 for couples 85 or older.
So, your monthly outlays will tend to be more stable and less onerous in your early retirement years. That gives the money you set aside for medical expenses in 401(k)s, IRAs, health savings accounts (HSAs), and other investments more time to grow before the big bills hit.
So, how can you protect against health care costs undermining your lifestyle in retirement? Here are a few tips.
Factor Health Care Costs Into Your Financial Plan
It's imperative that your financial plan takes medical costs into account. Estimate how much you'll need to save and how you're going to pay for it. "Put a health care plan in your overall plan," said Angie O'Leary, head of wealth planning at RBC Wealth Management.
When projecting health care costs, consider your health and family history. If you're a smoker or have a chronic condition like diabetes you should plan to spend more. But also factor in where you live. While the cost for traditional Medicare is the same everywhere, costs can be higher in some states for prescription coverage (Part D) and "Medigap" supplemental plans.
Knowing when you plan to retire is also an important consideration. Retiring before 65, the age you become eligible for Medicare, means you'll have to bridge the insurance gap. One option is COBRA, which provides 18 months of continued coverage after leaving an employer. But you might also consider a policy purchased through a state health insurance exchange or coverage through your spouse's plan.
Health Care Costs: Fill In Any Insurance Gaps
Your best defense is making sure you fill any coverage gaps that could result in a big financial hit, says EBRI's Fronstin. "It helps reduce uncertainty as to how much you'll pay," Fronstin said. It's also easier to budget when you have a better idea of your costs.
Consider Government-Provided Medicare Coverage
Many people think Medicare covers 100% of health care costs. But it doesn't. It won't cover eye exams, dental or hearing care, or long-term care at a nursing home. With traditional Medicare you'll pay a monthly premium and part of the cost for each covered service. And there's no yearly limit on what you'll pay for out-of-pocket expenses for hospital and medical coverage.
Medicare costs add up fast. For Medicare Part A (hospital insurance), most people pay $0 premiums plus a $1,556 deductible per benefit period. The premium for Part B (doctor visits, lab tests, etc.) starts at $170.10 a month but can rise as high as $578.30 depending on your income. And after you pay a $233 annual deductible, you'll usually pay 20% of the cost for each Medicare-covered service.
You'll also have to pay an extra premium (costs vary by plan) and meet a deductible for supplemental coverage, such as Part D (prescription drugs) and Medigap (private coverage that helps defray costs for Medicare Part A and B services by paying for out-of-pocket costs that could cost thousands of dollars a year).
Look At Your Options With Health Care Costs
You should check to see if a privately run Medicare Advantage plan (Part C), which bundles original Medicare Part A, B and D, is a more cost-effective option. While you'll still have to pay the government for your Part B premium and sometimes a premium for this private plan, you'll pay less as set copay amounts will likely be lower than the 20% copay for doctor visits under traditional Medicare. Medicare Advantage also has an annual cap on out-of-pocket expenses.
"It's very easy to fill the gaps, and you absolutely have to consider it," Fronstin said.
Keep in mind, too, you might be subject to a penalty if you don't sign up for Medicare when you're first eligible. So sign up on time.
Christine Benz, director of personal finance and retirement at Morningstar, said, "Not cheaping out on health insurance is money well spent."
Think About Long-Term Care
And all these insurance costs don't even include costly long-term care. That is the need for care in your home, assisted living facility or nursing home. The average monthly cost is $5,148 for an in-home health aide, $4,500 for an assisted living facility, and $9,034 for a private room in a nursing home, according to Genworth's "Cost of Care Survey."
How can you offset potential long-term care costs? If you can afford it, take out a stand-alone long-term care policy, or a hybrid life insurance policy with a cash value that you can tap to pay long-term care bills. Buying an annuity that provides guaranteed income is another option.
The alternative, paying out of pocket, can be costly and make it harder to pass on assets to heirs. "The money is lost in the nursing home," said Daniel Gottlieb, a co-author of RBC Wealth Management's report, "Taking control of health care in retirement."
Invest Wisely To Fund Medical Costs
Hopefully, you started saving early in accounts such as 401(k)s, Roth IRAs, and HSAs (health savings accounts). The goal: to have ample assets to draw upon when needed. Create a savings bucket for health care (or long-term care) just as you have a cash bucket for emergencies, a bucket for short-term needs like a car down payment, and a long-term bucket for retirement.
Ideally, you'll want to create a guaranteed income stream solely for health expenses that isn't impacted by market volatility or result in a tax bill every time you make a payment, says Maier of Ameriprise Financial.
Put Your IRAs To Good Use
Tax-friendly options include taking withdrawals from a Roth IRA or Roth 401(k), as you don't pay taxes on distributions. Or using your HSA account (which comes with a high deductible health plan) as an investment account. HSAs are one of the rare accounts that is triple-tax-free. Money goes in tax free, grows tax free, and is taken out tax free. If possible, sock away the annual HSA maximum contribution every year (the max for families in 2022 is $7,300) and invest the money in growth investments for future use. In the meantime, pay out-of-pocket expenses with other accounts.
"You get a tax break every step of the way," said Morningstar's Benz. "It's a lovely account type for people who can cover copays and other expenses without dipping into their HSA."
If you don't have a Roth IRA, now might be a good time to do a conversion, adds Maier. The reason: with stock prices much lower due to the big correction, the taxes you'll pay now to do the conversion are likely less than they were at the market top in early January.
In general, you'll benefit from having a balanced portfolio that will allow you to tap easy-to-access cash when needed but also have money growing in stocks for future health care outlays, says Benz.
