How much will your clients need to spend on health care in retirement? The numbers we often hear are so large that they bring to mind the “billions and billions” that late astronomer Carl Sagan spoke of so often on television.
Fidelity Investments, for example, recently published its annual estimate, showing that a 65-year-old couple retiring in 2019 can expect to spend $285,000 on health care and medical expenses throughout retirement. The Employee Benefit Research Institute estimated recently that a 65-year-old couple could need nearly $400,000 to meet lifetime expenses in a worst-case scenario.
That said, these estimates measure spending that will be spread across over 20 or more years of retirement. And to a great extent, these are expenses that advisors actually can help clients manage very well, because they are easy to predict.
A big chunk of change will go to Medicare premiums—Part B outpatient services, Part D prescription drugs and Medigap for those who choose original Medicare rather than Medicare Advantage. A model for planning health care costs in retirement published last year by Vanguard and Mercer found that a 65-year-old woman using original Medicare and a Medigap policy (Plan F) could expect to spend $5,200 in 2018 for health care.
Medicare smooths out the cost of many health care expenses. The question advisors really need to ask is this: What are the outsize risks that can wreck my client's retirement plan?
Health Care Inflation
The cost of health care—exclusive of long-term care needs—continues to rise much more quickly than overall inflation. But put in context, this may not be as large a risk as it appears.
Healthview Services, which publishes an annual report on health care costs, projects that retirement health expenses will rise at an average annual rate of 4.22%, outpacing general inflation and Social Security cost-of-living adjustments.
One important proxy for this increase is Medicare Part B premiums; the program’s trustees recently forecast that the monthly premium will rise next year nearly 9% to $144.30 (this year, it is $135.50.) Part B premiums are forecast to jump more dramatically in the years ahead, to $226.30 in 2028.
But in many cases, the rising health care inflation that your clients face will be offset by lower spending for other goods and services. For example, a study by David Blanchett, head of retirement research at Morningstar, found that retiree consumption tends to decline in real terms by about 1% annually.
Planning for long-term care risk is tough because of the emotional issues it raises for clients—and the difficulty getting a handle on actual risk.
Rand Corp. research concludes that 56% of people ages 57 to 61 will spend at least one night in a nursing home during their lifetimes. People in this age group run a 10% risk of spending three years or more in a nursing home and a 5% chance of spending more than four years in one.
Those longer stays pose major financial risks. The median annual cost of a private nursing home room this year is just over $100,000, according to Genworth’s annual cost-of-care survey, and it is far higher in some states.
“Long-term care is one of those things that is hard to grapple with for many individuals,” says Jean Young, a CPA and senior research analyst at the Vanguard Center for Investor Research and a co-author of the Vanguard-Mercer model. “This gets personal really quickly,” Young adds, “and as a population, we’re not good at numeracy. Everyone knows someone who has had an extended long-term care need.”
Private long-term care insurance has never caught on as a widespread solution, with perhaps 8% of eligible homes purchasing policies. Medicare covers up to 100 days of care in a skilled nursing facility following a hospitalization, and Medicaid is an option for some. But the Vanguard-Mercer researchers found that most care (72%) is paid out of pocket.
The authors urge planners to talk with clients about the different care options that might be available to them, and which they prefer. Also, take into consideration that the cost of paid care varies widely by the type of care consumed (home-based or institutional), by region and gender—Vanguard found that nearly six in 10 men can expect to consume no paid long-term care, while more than half of women will need it.
Financial assets should be considered both a source of annual income and a contingency reserve for large, unexpected expenses such as long-term care. The study also recommends taking home equity into account, as well as the possible addition of income annuities to protect against this risk.
“We think this is an opportunity to talk about income annuities that can cover whatever you believe will be basic living expenses,” Young says. “If a husband’s care needs consume the bulk of financial assets, a spouse can continue living on the income annuity and Social Security.”
I would add one more suggestion: Pay careful attention to claiming strategies that maximize Social Security benefits.
Medicare Part D insurance does a reasonable job of covering most routine prescription drug costs. But a recent study makes clear that there is a small but real risk of financial ruin for retirees who confront the need for very expensive specialty drugs.
The Kaiser Family Foundation report (KFF) found that the risk will impact “a relatively small share of enrollees,” but those who are affected will face serious financial problems.
Unlike most employer-sponsored insurance, Part D does not cap the total amounts that enrollees must pay out of pocket each year. That was a minor problem when the program launched in 2003, but the advent of very expensive specialty drugs has created new math. KFF studied expected annual out-of-pocket costs this year for 30 specialty drugs used to treat four conditions: cancer, hepatitis C, multiple sclerosis and rheumatoid arthritis. Median out-of-pocket costs ranged from $2,622 for Zepatier (for hepatitis C) to $16,551 for Idhifa (for leukemia).
Part D covers most outpatient prescription drugs. In 2019, the standard benefit can have a deductible as high as $415, and 25% coinsurance up to an initial coverage limit of $3,820 in total out-of-pocket spending.
It is very difficult to protect against this risk—Part D plans all charge similar amounts for specialty tier drugs, ranging from 25% to 33% coinsurance, so picking one plan over the other will not help much with the costs patients are required to pay. And, predicting a need for one of these drugs ahead of time is impossible.
Low-income Medicare enrollees who qualify for the program’s Extra Help program, which helps pay out-of-pocket Part D costs, do get relief from high out-of-pocket costs. The program is available to enrollees with very low levels of income and assets.
Enrollees with somewhat higher income may qualify for assistance with specialty drug costs direct from patient assistance programs funded by pharmaceutical companies, or direct from the companies.