Breaking up the numbers can replace the panic with planning.
July 22, 2019 By Sudipto Banerjee
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.
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).
•
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.)
•
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
Estimated
annual health care expenses for retirees
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.
Sudipto Banerjee is a senior manager of
thought leadership at T. Rowe Price.
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