For many, the largest unknown during retirement and a source of much concern and worry is the potential for “extraordinary” health-related expenses. These costs including Medicare, Medicare Supplement, prescription drug coverage, dental, vision and out-of-pocket costs (deductibles and co-pays) can vary greatly at an individual level.
When working on a Retirement Feasibility or Portfolio Sustainability Analysis for clients, we are very careful to realistically consider these costs and the possible impact that they may have on a retirement plan outcome.
A recent study conducted by Mercer Health and Benefits (June 2018) sheds some light on these costs and can help provide a realistic framework when making retirement projections for health-related expenses (excluding long term care costs). Here are some of the major takeaways:
Low Risk, Average Risk and High Risk
When it comes to projecting health care costs everyone is different and expense ranges can be substantial. According to the study, an individual in the “average risk” health category could expect to spend between $3,200 and $6,600 ($3,900 median) in annual health related expenses, whereas those in the “higher risk” category could see expenses in the $3,500 to $21,000 range ($7,600 median). Which category are you?
It is important to examine the impact of these varying personal circumstances when making long term retirement projections.
The Impact of Income Levels and the Decision of Which Account
Medicare Part B and Part D premiums rise as income levels rise. When planning for health-related expenses in retirement, it is essential to consider both current and projected future income levels as they can have a meaningful impact. It is also notable when evaluating future taxable income levels, the decision of “which account” has never been more critical.
Which account will primarily be utilized to fund your living expenses? More importantly, what impact do withdrawals from these accounts have on your taxable income? Those with larger IRAs will have larger required minimum distributions (RMDs), which may ultimately impact the cost of Medicare premiums.
The Substitution Effect
The study points out something we have noticed working with clients through the years—the “substitution effect.” As people age, their spending “buckets” ebb and flow. For example, in the beginning of retirement their leisure and travel “bucket” may be higher than their medical spending “bucket.” However, as people age, travel expenses may decline but health-related costs may increase. Total spending may not increase substantially, but the amount spent within each expense category may change.
The Impact of Inflation
While inflation levels for general spending have remained relatively tame, inflation rates on medical and health-related costs have continued to rise at a 5% to 6% clip. Many experts suggest that health care costs for retirees are likely to continue to rise.
As seniors and pre-retirees alike formulate their spending projections, it is important that these inflation-adjusted health care costs are considered. Failing to do so can create a false sense of security that assets will last throughout retirement.
A sound retirement plan will explore, not only the variability of health care costs, but also a host of other scenarios with the purpose of “stress testing” your plan. Going through this exercise can help pinpoint weaknesses, as well as lead to the discovery of solutions that will help your assets most effectively work for you! If you have any questions, please feel free to give our office a call.