How to Manage Healthcare Costs in Retirement

TV commercials convince us that people nearing retirement sit around thinking solely of going on international trips and spending time with grandkids. While that certainly happens, our experience is that health care issues are near the top of the list of things people worry about as they get closer to retirement. “Will Medicare cover all my healthcare needs?” “Will I need expensive long-term care services when I’m older?” The questions are in response to what we all inherently know – that healthcare costs have spiralled in recent decades.

How do you manage healthcare costs in retirement? That’s the question we address in this article. We not only look at the high cost of healthcare in retirement, but ways you can prepare for that before retiring. We also look at long-term care, which many people worry about not only for what that means with one’s health, but for the high cost of getting long-term care. 

Twin Challenges: High Medical Cost Inflation and Rising Medicare Premiums

It’s safe to say that all of us are very aware of the high cost of medical care in the United States. When you add up insurance premiums, copays, coinsurance, and prescription costs, medical costs can eat up a meaningful portion of our budgets. Official government statistics, seen below, demonstrate this to be the case. But inflation is only one aspect of increasing healthcare burdens. These official statistics do a poor job of capturing other expenses, such as higher co-pays, higher deductibles, and higher insurance costs.

The other major issue retirees face is the increasing cost of Medicare. Everyone in America is required to enroll in Medicare at Age 65 unless they have health insurance from a qualified employer plan. Medicare Part B premiums start at $185/month, but can rise to over $600/month depending on your annual income. Worse, since Medicare was launched in 1965, Medicare Part B premiums have risen at a 6.0% average annual rate, a trend that’s forecast to continue in the years ahead.

These two health cost headwinds present serious challenges to anyone saving for retirement. The time to prepare for healthcare costs in retirement is before you’re ready to retire, at least 10 years in advance. 

How Much Will Healthcare Costs Be in Retirement? 

Estimating potential healthcare costs in retirement is like trying to predict the weather in 10 years. We can make educated guesses on what the costs will be, but cost estimates should be taken with a grain of salt as a lot can happen in 10 years.

But there are some factors to consider when you think about how much money you might spend on healthcare in retirement. These factors include:

There have been studies by companies such as Mercer, Fidelity, and Vanguard to estimate potential healthcare costs for people entering retirement. These studies suggest men will spend $150,000 on healthcare needs while retired, while women will spend $170,000 because of living longer than men. Taken together, a married couple could face total medical costs of $300,000 while retired. If this sounds like a big number, it is! 

This highlights the need to save for retirement while you’re working. Those savings are not just going to fund day-to-day living expenses, vacations, and the like. But also your healthcare needs. Later in this article, we talk about how you can use a Health Savings Account strategy to create a dedicated pool of savings to cover medical needs in retirement.

Medicare Costs and Coverage in Retirement

Once you’re 65, you must enroll in Medicare unless you’re still working for a large company (20 or more employees) and covered by their health insurance plan. Spouses covered under their spouse’s employer health insurance can also wait to enroll in Medicare. 

There are four “parts” of Medicare that you should know about. The first two – Part A Hospital Insurance and Part B Medical Insurance – are the base parts of Medicare. Meaning, those two parts are the starting point for the rest of your Medicare coverage. Parts A & B are NOT designed to cover all your healthcare needs in retirement. They only cover basic needs, not routine health needs or prescriptions. 

To get full coverage, you will have to purchase either a Medigap policy or Medicare Advantage policy. These two types of policies, while different, provide coverage similar to what you might have with an employer insurance plan. Key features include regular doctor visits, coupled with deductibles, copays, and maximum out-of-pocket expenses. We’ll show you key differences between a Medigap policy and Medicare Advantage, but the important takeaway to understand is that after enrolling in “basic” Medicare Parts A & B, choose either a Medigap policy (also called Medicare Supplemental Insurance) or a Medicare Advantage plan.

Below, we summarize total annual costs for Medicare, which can vary depending on income. Base Part B premiums apply to everyone, but these premiums may be higher with income-related adjustments if your annual income is high. Likewise, the cost of Medicare Advantage and Medigap plans will depend on your location and possibly your health needs. 

If you’re married, remember that Medicare costs are per person. Meaning, your household will incur two distinct Medicare costs each year. Putting real numbers on this, we can consider two married couples, one with an annual income of $150,000 per year and the other with an income of $250,000. 

On top of these direct Medicare expenses, you may have additional costs to cover deductibles and prescriptions. But it’s pretty clever that even with Medicare, the cost of healthcare in retirement is high!

How to Estimate Long-term Care Needs in Retirement

The final enormous challenge with estimating future healthcare costs in retirement is long-term care. There’s a lot under the umbrella of “long-term care.” But this means assisted living or memory care – either in your home or in a nursing facility. Depending on location, an assisted living facility may cost $8,000/month while memory care can easily cost more than $10,000/month.

Much like estimating an individual’s health care costs in the future, estimating their need for long-term care is extremely difficult. Why? Based on statistics, about half the population won’t need long-term care when they’re older. But the other half of the population that does can incur very high costs.

Trying to come up with an “average” cost for long-term care is impossible. Think about the various potential outcomes:

• 52% chance of not needing long-term care at all
• 21% chance of needing long-term care costing less than $100,000
• 9% chance of needing long-term care that costs between $100,000-$250,000
• 18% chance of needing long-term care that cost more than $250,000

The bad news with long-term care is that it’s getting prohibitively expensive to buy long-term care insurance to cover this cost. Insurance carriers severely mis-priced long-term care policies in the 1990s and early 2000s. Since then, premiums have skyrocketed and coverage has fallen, making these policies less useful. However, we always help clients look at long-term care insurance as they reach their 50s, which is the ideal age to shop for this type of insurance.

How Health Savings Accounts can Cover Healthcare Costs in Retirement

Now that we see how difficult – and potentially expensive – healthcare costs can be in retirement, the question is what do we do about it? As financial planners, we use two main approaches: Health Savings Accounts and stress-testing retirement plans for long-term care events. 

Health Savings Accounts (“HSAs”) are a relatively recent phenomenon, but can be a powerful retirement savings tool. A detailed review of HSAs are in the linked article, but the takeaway is that an HSA savings strategy can create a “pool” of retirement funds that’s specifically tailored to cover healthcare costs in retirement. This way, we can help a client save enough into an HSA to cover healthcare needs, while clients use other retirement savings (IRAs, 401(k)s) for day-to-day living expenses, vacations, and other goals. 

However, companies promote HSAs to workers as a tool to pay for healthcare costs before retirement. For example, a family may make a maximum contribution to an HSA this year, but then use the debit card they get from the HSA to cover doctor visits, glasses, and other health-related costs for the family in the same year. There is nothing wrong with using an HSA this way, as you save on taxes with the HSA contribution. But it misses out on the real benefit of HSAs – long-term investment growth.

If we have a client whose family is in relatively good health, we may recommend they use an HSA-qualifying medical plan at their employer. And instead of using annual HSA contributions to cover current medical needs, we may recommend they invest those contributions for future growth, much like they do for their 401(k)s. You’d be surprised how that money adds up after several years of contributions and growth. Then, in retirement, that money can cover qualifying out-of-pocket medical expenses, avoiding having to “dip” into their IRAs and 401(k)s.

Stress-Testing Retirement Plans for Long-term Care Events

Aside from explicitly setting money aside in an HSA to cover healthcare expenses in retirement, the other strategy we use to help clients is to stress-test their retirement plan for long-term care events. This becomes an important tool to use if there is a family history of parents or grandparents needing long-term care facilities in their old age, as that increases the chances that the current generation will also need such care.

How do we stress-test for long-term care? Statistically, someone that ends up in an assisted living or memory care facility ends up staying in that facility for 2-3 years before passing away. Obviously, there are plenty of examples of people staying in a long-term care facility for over 3 years. To account for this uncertainty, we may assume that the client will need five years of assisted living at an average cost of $10,000/month, adjusted for future inflation. This potential expense would start at a certain age, normally informed by the client’s experience with parents or grandparents entering a facility in their mid-80s.

In this example, a client may face a $600,000 long-term care bill at Age 85, which is $10,000/month for 60 months, adjusted for inflation. That’s obviously an enormous expense to build into one’s retirement plan. But remember, there are offsets. Presumably, non-long-term care housing costs would decline, as would day-to-day expenses. And if we’re assuming an annual travel budget, those costs would presumably go away if the client is living in a facility.

We then run these assumptions into a client’s retirement plan and see if their current retirement savings suffice to cover such a scenario. If their savings are enough, we may recommend that the client “self insure” for a long-term care event versus paying for an expensive long-term care insurance policy. If savings might not be enough, we may recommend they set more money aside for retirement. 

With both approaches – using HSAs and stress-testing retirement plans – our goal is to help the client understand how healthcare costs in retirement may affect them.

How to Manage Healthcare Costs in Retirement

There are many challenges with retirement planning. Estimating your future healthcare costs is one variable that can make or break your retirement plan.

We’ve seen the challenges of trying to estimate what these costs will be many years into the future. Despite that, we can help you “stress test” your future retirement using a wide range of assumptions. That way, you’ll know whether you need to save more for those contingencies.

For people still working, a Health Savings Account is a great tool to insure yourself against the risk of high healthcare costs in retirement. Treat HSAs just like your 401(k) or IRA – invest aggressively for the long-term and let those funds grow. If you have high medical costs when you’re older, you’ll have comfort knowing you have a dedicated pool of funds to draw from.

Building retirement healthcare costs into your financial plan is just one piece of the retirement planning puzzle. For the corporate executives we work with, we also create plans for the equity compensation they receive and other executive compensation benefits. A client working with FDS on their financial plan year-in, year-out is going to experience more confidence with their financial situation as they enter retirement. We can’t control what happens in life. But we can think critically about what might happen and plan for those contingencies so if those things happen, they don’t totally derail your retirement.

Bonus: Retirement Planning Guide