The issue of health care costs in retirement -- and planning for them well in advance of retirement -- is becoming key to any retirement planning discussion.
A recent study by Employee Benefit Research Institute (EBRI) sheds light on different types of health care costs to consider in retirement. It projected that in 2014, men and women who wanted a 90% chance of having enough money to cover out-of-pocket health care expenses in retirement would need to have saved $116,000 and $131,000 respectively by age 65.¹ This is a sobering goal when you consider that just 42% of workers in their 50s and 60s report total savings and investments in excess of $100,000.²
Part of the problem with putting a price tag on retiree health care expenses is that every situation will vary depending on an individual's health, the type of health care coverage they carry, and when they hope to retire. That said, EBRI has identified some "recurring expenses," or standard elements of cost that can be estimated and planned for in advance as well as "non-recurring" expenses that are less predictable but tend to increase with age.
Recurring vs. Non-Recurring Expenses
EBRI was able to categorize utilization patterns and expenses into these two separate types of health care services using data gleaned from the Health and Retirement Study (HRS). HRS is a longstanding, highly respected study of representative U.S. households evaluating individuals over age 50.
● Recurring services -- These include doctor visits, prescription drug usage, and dentist services. Since these services tend to remain stable throughout retirement, it is possible to calculate an average out-of-pocket expense among individuals age 65 and older of $1,885 annually.³ EBRI's study projected forward, and factored in the following assumptions: a 2% inflation rate, a 3% rate of return on investments, and a life expectancy of 90 years. The study estimated that one would need $40,798 at age 65 to cover the average out-of-pocket expenses for recurring health care needs throughout retirement. It should be noted that this calculation does not include expenses for any insurance premiums or over-the-counter medications.
● Non-recurring expenses -- This category includes overnight hospital stays, overnight nursing home stays, home health care, outpatient surgery, and special facilities. Unlike recurring expenses, the cost of most non-recurring services increases with age. For example, average annual out-of-pocket expenses for nursing home stays are estimated at $8,902 for those in the 65 to 74 age group, $16,948 for those aged 75 to 84, and $24,185 for individuals aged 85 and up.³
Because the likelihood of utilizing these services and the degree to which they will be needed is largely unknown, projecting the savings needed to cover these costs throughout retirement is an elusive exercise. One way to estimate expenses for yourself is to start with the total out-of-pocket health care savings goals of $116,000 for men and $131,000 for women cited earlier. Then, divide these estimated expenses into recurring and non-recurring costs.
Bigger Picture Planning
Certified Financial Planners™ often recommend taking a holistic approach to calculating income needs in retirement, by factoring in such costs as taxes and debt payments along with other typical expenses including health care. In addition to the out-of-pocket health care calculations discussed above, consider what you think you might have to pay in annual premiums if you were to apply for health insurance today. Lastly, and perhaps most important, add in an allowance for inflation -- both general and health care inflation.
Your Certified Financial Planner™ can help you get started by creating a Comprehensive Financial Plan that includes a projection for health care costs in retirement. This is especially useful just before you "pull the trigger" on your decision to retire, and give notice to your employer. Knowing that your plan will work can give you the confidence to move forward.
This article offers only an outline; it is not a definitive guide to all possible consequences and implications of any specific saving or investment strategy. For this reason, be sure to seek advice from your CPA and Certified Financial Planner™.
¹ Employee Benefit Research Institute, news release, "Needed Savings for Health Care in Retirement Continue to Fall," October 28, 2014.
² Employee Benefit Research Institute, 2014 Retirement Confidence Survey, March 2014. (Not including the value of a primary residence or defined benefit plans.)
³ Employee Benefit Research Institute, "Utilization Patterns and Out-of-Pocket Expenses for Different Health Care Services Among American Retirees," February 2015.
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