Retired Couples Need $325,000 to Pay for Medical Expenses: EBRI

Robert Powell, CFP®

Call it a wake-up call.

A 65-year-old couple, whose drug expenses are in the 90th percentile and who want a 90% chance of having enough money to pay health care expenses throughout retirement, need savings of $325,000 in 2020. 

And 65-year-old couples with median prescription drug expenses who want a 50/50 shot of paying for health care expenses throughout retirement need savings of $168,000. For a 90% chance of having enough, that same couple needs $270,000 in savings. 

"I hope it is a wake-up call," said Paul Fronstin, director of the health research and education program at the Employee Benefit Research Institute (EBRI) and co-author A Bit of Good News During the Pandemic: Savings Medicare Beneficiaries Need for Health Expenses Decreases in 2020. "This is a serious situation that people may not have enough money to cover their health care."

What's more, Fronstin noted in an interview, the older you get, the more health care you're going to need. "That's a fact," he said. "So hopefully people would be prepared or this (research) will cause them to start working on a plan to become prepared."

The EBRI report examines the savings needed to pay for premiums for Medicare Parts B and D and Medigap Plan G, as well as out-of-pocket spending for outpatient prescription drugs. Medicare generally covers only about two-thirds of the cost of health care services for Medicare beneficiaries ages 65 and older. 

"We take an over-simplistic approach by assuming everybody has really good insurance," said Fronstin. "We do that to take away the uncertainty related to using health care." 

The projected savings do not, however, include the cost of long-term care, which Fronstin said is a "big uncertainty" and could easily double the savings needed to pay for health care and medical expenses in retirement.  Fronstin did note, however, that "very few people need long-term care." 

Read Cost of Long Term Care by State | Cost of Care Report to learn the potential costs associated with long-term care.

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To be fair, there was some good news in the EBRI report. In 2020, the predicted saving targets for Medicare beneficiaries to cover health premiums, deductibles, and certain other health expenses in retirement have fallen between 8 and 10% since 2019. And these are the biggest declines the authors of the EBRI report have seen since 2012, with the exception of 2013, when needed savings declined between 6 and 11%. 

Chart showing how much money is required to pay for health care and medical expenses in retirement
EBRI

According to EBRI, the main reason for the decrease in needed savings from 2019 to 2020 is related to the adjustment made each year to re-establish the baseline for out-of-pocket spending associated with prescription drug use. 

The Medicare Trustees reduced projected costs for Medicare Part D premiums and out-of-pocket expenses. Projecting these and other changes in Medicare Part D out-of-pocket spending over the course of one’s lifetime results in a significant reduction in savings targets for Medicare beneficiaries who would benefit from such changes the most — those with prescription drug spending at the 75th and 90th percentiles throughout retirement. 

Some of the reduction is also due to a change in EBRI’s model from using data from Medigap Plan F to Plan G. 

Other key findings

  • In 2020, a 65-year-old man needs $73,000 in savings and a 65-year-old woman needs $95,000 in savings for a 50% chance of having enough to cover premiums and median prescription drug expenses in retirement, according to EBRI.
  • For a 90% chance of having enough savings, the man needs $130,000 and the woman needs $146,000, according to EBRI. The good news? The amount of savings a man or woman needs to fund medical expenses in retirement is down 10% from 2019.

The data used in EBRI’s analysis come from a variety of sources. EBRI employs a Monte Carlo simulation model for its evaluation that simulated 100,000 observations, allowing for the uncertainty related to individual mortality and rates of return on assets in retirement.

By way of comparison, Fidelity Investments estimated that a 65-year old couple retiring in 2019 could expect to spend $285,000 in health care and medical expenses throughout retirement, compared with $280,000 in 2018. For single retirees, the health care cost estimate was $150,000 for women and $135,000 for men.

EBRI, by contrast, doesn't "give one number because we think that while one number is helpful... it's also potentially misleading," said Fronstin. "If you give an average... and you plan to be average you've got about a 99% chance of being wrong. You may be wrong by a little bit or you may be wrong by a lot. So we give a range of estimates that vary for the most part with longevity because the longer you live in our model, the more money you're going to need because it means you're paying premiums for that many more years."

It's worth noting, too, said Fronstin, that retirees don't necessarily need to have this money earmarked for health care expenses set aside at retirement. "You could pay these expenses out of pocket each year," he said. "You pay your premiums each year, you pay your deductibles each year for part B and part D. But just to give people a sense of the magnitude, we thought it was important to come up with the lifetime number."

According to EBRI, the main reason for the decrease in needed savings from 2019 to 2020 is related to the adjustment made each year to re-establish the baseline for out-of-pocket spending associated with prescription drug use. The Medicare Trustees reduced projected costs for Medicare Part D premiums and out-of-pocket expenses. Projecting these and other changes in Medicare Part D out-of-pocket spending over the course of one’s lifetime results in a significant reduction in savings targets for Medicare beneficiaries who would benefit from such changes the most — Medicare beneficiaries with prescription drug spending at the 75th and 90th percentiles throughout retirement. Some of the reduction is also due to a change in EBRI’s model from using data from Medigap Plan F to Plan G.

So, how might one put this report into perspective? How might pre-retirees go about planning for medical and health care expenses in retirement?

Present Value is the Value of All Future Cash Flows (Positive and Negative)

First a bit of perspective. Most Americans don’t retire with a pot of money just for medical and health care expenses. To be sure, some advisers recommend that. But it’s not the reality today. Most people pay for medical and health care expenses in retirement out of cash flow, from savings, earned income, Social Security, pensions and other sources of income on an annual basis. And viewed in that context, the health care number seems a bit more manageable and less overwhelming.

Consider: the numbers suggested by EBRI, Fidelity, and others represent the present value of a stream of annual expenses over the course of retirement. But, in reality, couples with median prescription drug expenses that want a 50% chance of having enough to cover health care expenses in retirement don’t really need $168,000 in savings - at retirement. They would need to come up with, say $14,500 per year, over the course of a 20-year retirement, or $12, 200 over a 30-year-retirement.

Should You Buy a Medigap Policy?

Given that EBRI's research factors in the savings needed to pay for Medigap Plan G premiums, we asked Fronstin whether older Americans should contemplate doing so as well. 

In 2015, only one in four people in traditional Medicare had private, supplemental health insurance —also known as Medigap—to help cover their Medicare deductibles and cost-sharing requirements, as well as protect themselves against catastrophic expenses for Medicare-covered services, according to the Kaiser Family Foundation. Read https://www.kff.org/medicare/issue-brief/medigap-enrollment-and-consumer-protections-vary-across-states/.

According to Fronstin, there's no easy answer to the question. And it's made even more difficult by the fact that EBRI's research doesn't model the costs of Medicare Advantage plans, which need to be considered as well. More than 24 million Medicare beneficiaries (36%) are enrolled in Medicare Advantage plans in 2020, according to the Kaiser Family Foundation. Read https://www.kff.org/medicare/issue-brief/a-dozen-facts-about-medicare-advantage-in-2020/.

EBRI hasn't modeled the costs of Medicare Advantage plans into its research for one big reason. It's complicated to do because premiums for Medicare Advantage plans are all over the map. And in the EBRI model, the goal is "to minimize the uncertainty related out of pocket expenses," Fronstin said.

Still, Fronstin said older Americans should evaluate Medicare Advantage plans as well as Medigap plans because it may be a better option for them. "Everybody's situation is going to be different. So they shouldn't just take our model and assume that's what's going to be best for them," he said. 

How to Pay for Health Care Expenses in Retirement

According to Fronstin, it's likely that older Americans will need a variety of sources to pay for health care expenses in retirement, including savings, earned income, Social Security, and the like.

Fronstin noted that health savings accounts (HSAs) can play a role but such accounts are "unlikely to play a significant role for people who are near retirement because they haven't been around long enough to build up a significant balance in there."

For younger adults, however, HSAs offer the best possible tax advantages for those trying to save a pool of money to pay for health care expenses in retirement.  "To the degree you could set money aside in an HSA and not touch it, that's great," said Fronstin. 

Read https://www.thestreet.com/retirement-daily/planning-living-retirement/planning-and-paying-for-healthcare-expenses-in-retirement-14823317.

Ultimately, Fronstin said, "you have to look at your specific situation. What kind of savings do you have, where is it and what makes the most sense. Recognize that you might be able to cover this by just spending a part of your income every year."

On average, older Americans spend about 5 to 15% of their income on health care expenses in retirement. Read https://www.bls.gov/opub/btn/volume-5/spending-patterns-of-older-americans.htm.

Maintain a Healthy Lifestyle

Another way to reduce the possible cost of medical expenses in retirement is to maintain a healthy lifestyle before retirement. Though everything does come with a cost. Said Fronstin: "It (maintaining a healthy lifestyle) is going to play a role in how much you spend on everything else too, right? Because if you're healthy, you're out there being active and doing things and that potentially costs money, too. But you know, you have to weigh it: Would you rather spend your money going to the doctor and on prescription drugs or would you rather spend your money doing some leisure activity? It doesn't necessarily make you richer, but it certainly affects your quality of life."

 A Contrary Point of View

Carolyn McClanahan, M.D., a certified financial planner with Life Planning Partners, has come "to the conclusion that trying to predict medical expenses as a lump sum is a waste of time."

"As this EBRI report shows, many variables can affect their predictions – recessions and people using less health care (because they either can’t afford it, are tired of dealing with your broken system, or now – fear of coronavirus) have a significant effect on the final numbers," she said.

Here's the way McClanahan is planning for her client's health care expenses:

  • What are they spending for out-of-pocket care now, including non-traditional expenses such as massage therapy, chiropractic care, etc.? Put this in as a regular cash flow item inflated at normal inflation.
  • Include the yearly current cost of their health care premiums. At age 65, put in the cost of the Medicare premiums.

She also uses the average inflation rate for all products and services to calculate future health care expenses, instead of the current rate of inflation for health care, 4.8%. "Anything more than that is unsustainable in the long term," she says. 

Of note, the long term average rate of health care inflation is 5.28%, according to the Bureau of Labor Statistics.

Inflation rate

Listen to Paul Fronstin discuss the study: 

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