Heart-Pounding Costs for Healthcare in Retirement? Take a Deep Breath

Do you have more than a quarter of a million dollars to cover healthcare costs and medical expenses? Some people probably do, but most don't.

And yet, that's the number: A 65-year-old couple will need $280,000 to cover healthcare and medical expenses throughout retirement, according to Fidelity Investments' 16th annual retiree healthcare cost estimate. That's a 2% increase from 2017 and a 75% increase from Fidelity's first estimate in 2002 of $160,000.

But here's what you really need to know about that number.

Present Value of Annual Expenses

That number -- $280,000 -- represents the present value of many years of expenses that the average couple will pay per over the course of their lives, with life expectancies that align with the Society of Actuaries' RP-2014 Healthy Annuitant rates.

So let's put things in perspective: A man reaching age 65 today can expect to live, on average, until age 84.3 and a woman turning age 65 today can expect to live, on average, until age 86.6.

This means, for simplicity's sake, the average couple will spend roughly $17,278 per year over the course of 20.4 years of retirement and each spouse would spend $8,639 per year. That number, though high, (and higher than what people currently pay for healthcare in retirement) is much more manageable than thinking you need $280,000 set aside when you retire just to pay for healthcare -- especially when you consider that many 65-year-old couples don't have that much set aside to pay for all their retirement expenses.

"Nobody really needs a lump sum set away at retirement to plan for ongoing cash flow expenses," says Carolyn McClanahan, the founder of Life Planning Partners. "To me, people should plan for healthcare expenses as a cash flow expense and don't try to earmark it separately."

Don't Trust Averages

The Fidelity number is -- it's important to note -- just an average and you are likely not average. Your healthcare expenses in retirement might be less, might be more. The key is to calculate what your number will be, how you pay for your healthcare expenses in retirement, and what you can do to control what you pay for healthcare in retirement.

"The problem that I have with this study is that it gives an average," says McClanahan. "And nobody is average, is the first problem."

Others share that opinion. "While I appreciate Fidelity and others providing more awareness to this most serious of retirement planning issues, the actual planning is very household-dependent and should never be based on 'averages,'" said Jim Koch, financial adviser with Koch Capital Management. "I know this is obvious, but healthcare costs are so varied from person to person."

As with mortality, Koch says your actual healthcare spending after the age of 65 varies hugely. "Thus, it's nearly impossible to apply average numbers to individual clients, but at least it's a start," he says.

Koch also says his biggest issue with these reports is that they don't capture dependence risk where a health-related crisis often kicks off a cascading series of other financial hardships, such as missed mortgage payments, jump in credit card debt, inefficient tax liquidation of assets, and the like.

Different Research, Different Numbers

It's also worth noting that even though Fidelity's numbers have become institutionalized in the financial planning community, other organizations that calculate healthcare costs in retirement have entirely different numbers that don't necessarily have the same shock and awe value.

For instance, this Employee Benefit Research Institute study estimated how much retirees spend on out-of-pocket healthcare expenses after age 70 until their death. And what this study found was this: For most surveyed people, out-of-pocket healthcare expenses are not as high as commonly believed. For those who die at age 95 or later, the median cumulative out-of-pocket expense after age 70 until death is slightly above $27,000.

Another EBRI study, Utilization Patterns and Out-of-Pocket Expenses for Different Healthcare Services Among American Retirees, also found that recurring predictable out-of-pocket health-care expenses remain somewhat stable over the course of retirement. In its research, EBRI found that average annual out-of-pocket healthcare costs for a household between 65 and 74 years old was $4,383 in 2011, which accounted for 11% of total household expenses. But out-of-pocket healthcare expenses rise for households ages 85 and above to $6,603 a year, or 19% of total household expenses.

The average annual expenditure for recurring healthcare expenses, such as doctor visits, dentist visits and usage of prescription drugs, among the Medicare eligible population was $1,885. According to EBRI, assuming a 2% rate of inflation and 3% rate of return, a person with a life expectancy of 90 would need $40,798 at age 65 to fund his or her recurring healthcare expenses. This does not include expenses for any insurance premiums or over-the-counter medications, EBRI noted.

Some Expenses Are Catastrophic

What the EBRI studies do show however is that healthcare expenses in retirement are catastrophic for some. For instance, for those who die at age 95 or later, the 90th and 95th percentiles are nearly $172,000 and just over $269,000, respectively. In other words, the distribution of cumulative out-of-pocket medical expenses is skewed toward those with higher expenses.

Of note, nursing home expenses are one of the biggest contributors driving the skewness of the distribution, according to EBRI. Without out-of-pocket nursing home expenses, the 90th and 95th percentiles for those who die at age 95 or later drops to nearly $96,000 and $154,000, respectively, EBRI noted in its study.

EBRI also noted that non-recurring unpredictable expenses -- surgery, hospitalizations, and nursing home care, for example -- increase with age, tend to be more expensive, and, in the absence of a plan to manage those costs, can wreak havoc on a household's finances.

Of note, Fidelity's estimate does not include other health-related expenses, such as over-the-counter medications, most dental services and long-term care.

You can find what long-term costs are by state at this website. You can get a sense of long-term care insurance rates at this website.

How Most People Really Pay for Healthcare

Most people pay for healthcare in retirement with a mix of income, including earned, and assets and Social Security. No one really pays for healthcare with just financial assets. And indeed, Fidelity's study confirms this.

"When early retirees were asked how they were paying for out-of-pocket premiums, co-pays and deductibles associated with insurance coverage, 49% indicated they were dipping into personal savings to cover these expenses. Nearly one-quarter (24%) were relying on Social Security income, or retirement savings (15%). And 14% of respondents were using a health savings account (HSA) to cover these costs.

Present Value of Expenses and Income

Calculating the present value of your personal retirement expenses, including housing and healthcare, is a worthwhile exercise. It's also worth calculating the present value of your retirement income, including Social Security, earned income and personal assets. Doing so will give you a sense of whether you're able to fund your desired lifestyle in retirement and how you will do it.

"I agree wholeheartedly with the PV estimate of healthcare costs," says Koch. "It's the best we got until medical technology becomes more predictive and big data models become more accurate."

But the real issues, according to Koch, are: One, what future cost values to use, and two, what inflation rate(s) to use.

Look at the healthcare cost calculators in the Retirement Daily tools and resources section.

As you calculate the present value of your expenses, you might also consider the degree to which you are underfunded, funded, or overfunded. To determine your funded ratio, you would divide the present value of your income by the present value of your expenses.

A ratio greater than one means you're funded, and a ratio below one means you're underfunded.

"Like so many things, the out-of-pocket costs of healthcare in retirement fall most heavily on those who are constrained or underfunded and who have significant healthcare needs," says Michael Lonier, the founder of Lonier Financial Advisory. "Those who are well-funded can budget their out-of-pocket costs and cover them like any other expense category in their budget, out of their retirement income cash flow, which includes Social Security, pensions, and, for the well-funded, a significant annual amount from savings, usually over half of their planned annual income."

Personalize Your Healthcare Number

McClanahan says it's wise to think about your and your spouse's longevity, and how well you and your spouse take care of yourselves, and what benefits you might need. For example, are you high healthcare users, or low healthcare users?

Use the Social Security Life Expectancy Calculator, the Livingto100 Life Expectancy Calculator and the Actuaries Longevity Illustrator to get a sense of your life expectancy.

Other Smart Things to Do

1) Purchase a Medicare Supplement Insurance (Medigap) policy. Such a policy helps pay some of the healthcare costs that Original Medicare doesn't cover, like: copayments, coinsurance and deductibles.

2) Evaluate whether a Medicare Advantage plan, which are used by one-third of all Medicare beneficiaries, makes sense for you.

According to the Medicare.gov, Medicare Advantage plans provide all your Part A and Part B benefits. Medicare Advantage Plans include:

Health Maintenance Organizations (HMOs)

Preferred Provider Organizations (PPOs)

Private Fee-for-Service Plans

Special Needs Plans

Medicare Medical Savings Account Plans

If you're enrolled in a Medicare Advantage Plan:

Most Medicare services are covered through the plan

Medicare services aren't paid for by Original Medicare

And most Medicare Advantage Plans offer prescription drug coverage.

Of note: Medigap policies can't work with Medicare Advantage Plans.

"If you are the type of person who can deal with a Medicare Advantage plan and you don't plan on going out of network, your healthcare expense could be very, very low," says McClanahan. "Don't pay attention to (Fidelity's) numbers so much as what your healthcare choices will be now and, in the future, as far at the type of healthcare you want."

For his part, Lonier says those who have serious, chronic medical conditions need to consider an additional retirement planning step -- finding a retirement location where Medicare insurance options, particularly Medicare Advantage (Part C) options, are plentiful and where medical practices are tuned into the retirement community.

"In such locations, a retiree with an Advantage policy from one of the major insurers will get the best medical care at bargain prices, since in those locations most practices accept Medicare and belong to the major insurer networks -- generally, in major retirement markets, a $0 monthly premium," he says. "In other locations they may find fewer Advantage plans, higher premiums, or limited networks that do not provide the range of care they may need."

According to McClanahan, the people who have the high healthcare expenses are the people who want lots of flexibility, to be able to go to doctors everywhere. "It's you attitude toward healthcare and how you plan to use it that drives cost more than anything else," she says. 

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