How to Prepare for Healthcare Costs in Retirement

It’s no secret retirees spend a lot of money on healthcare. Between rising premiums, deductibles, co-pays, and other out-of-pocket expenses, it’s easy to see how healthcare could eat up roughly 15% of a retirement budget. Proper healthcare planning is an important pillar of any strong retirement plan. So how can you prepare for these costs? Our team is here to help. 

Rising Healthcare Costs in America

Before you can plan for healthcare expenses, it’s good to understand this upward trend and why spending has increased in our society. 

Healthcare costs have risen since the 1970s due to changes in government programs as well as the shifting needs of the population. According to data from the National Health Expenditure (NHE), total healthcare spending in 1970 was $74.6 billion; in 2018, that number exceeded $3.6 trillion. This averages out to $11,000 per person, with some spending significantly more than others. 

The Centers for Medicare and Medicaid Services (CMS) projects these spending patterns to increase. Their data suggests that by 2028, total healthcare spending will increase to $6.2 trillion — or $18,000 per person — and comprise about 20% of the gross national product. With the effects of COVID-19, these projections could sharply increase as medical care needs and services rise. 

Why is Spending Growing So Fast?

The reasons for growth relies on several factors:

  • Increased population growth
  • An aging population 
  • A rise in medical costs

Healthcare becomes more expensive the more people use it. As the population grows and lives longer, in-patient care costs and hospital expenses have also grown. 

The Consumer Price Index (CPI) found costs for medical expenses have increased faster than other consumer goods — 3.5% per year (compared to 2.1% for other goods and services). This increase in prices naturally leads to higher spending. 

The spending uptick also tracks with rising out-of-pocket spending for basic expenses: this includes premiums and deductibles. The Kaiser Family’s Foundation 2019 Employee Benefits Survey found premiums grew approximately 5%. The report also noted premiums for family coverage have increased 54% over the past decade, which far surpasses inflation or wages.  

But the costs don’t stop there. Deductibles have steadily increased for years now, especially with the popularity of high deductible health plans. The chart below shows data from the Peterson-Kaiser Health Systems tracker regarding the rise in deductibles from 2006-2016.  

Where is the Money Going?

The American Medical Association (AMA) broke down the areas of healthcare spending, finding hospital care and physician services made up the largest portion of costs.  

  • Hospital: 32.7%
  • Physician Services: 15.5%
  • Personal health care costs: 15.1%
  • Prescription drugs: 9.2%
  • Health insurance: 7.1%
  • Investment: 4.8%
  • Nursing care: 4.6%
  • Clinical services: 4.4%
  • Home healthcare: 2.8%
  • Government public health: 2.6%
  • Government administration: 1.3%

This explains some of the general healthcare spending in the U.S, but how can this data help you prepare for your own costs in retirement?

Healthcare Spending in Retirement

According to the most recent Fidelity study, an average couple can expect to pay $285,000 in healthcare costs alone in retirement. 

While this number includes deductibles, co-pays, premiums, prescriptions, and other Medicare costs, it doesn’t account for healthcare costs like dental, vision, over-the-counter medications, and long-term care. 

Long-term care expenses should be an essential part of your planning strategy. Why? Over 50% of people 65 or older will require some type of long-term care in their lifetime. Genworth found the average cost of nursing care is $102,200 for a private room and $90,155 for a semi-private room. If you needed nursing care for just one year, you could accrue significant medical bills. 

This makes saving and planning for healthcare costs in retirement even more imperative. The key is to start saving early and continue to evaluate both current and projected health needs to make a solid plan that will support your future.

Create a Strong Retirement Income Plan

A large part of retirement planning is allocating expenses that will help you live the life you want. When planning for medical costs, it’s necessary to account for all income streams you will have available, such as:

  • Your portfolio
  • Specific retirement accounts (401k, IRA, etc.)
  • Social Security
  • Pension
  • Part-time work
  • Other personal savings (real estate or other assets)

This will help you understand what you have and how to divide that income in the best way possible. 

Your income is also a great predictor of what you can expect to pay for Medicare Part B and Part D premiums. Most people will pay $144.60 (the average Part B premium for 2020), but you can expect that number to increase if your income surpasses certain limits. 

If your modified adjusted gross income from two years ago is above a certain threshold, your monthly payments will increase due to the Related Monthly Adjustment Amount (IRMAA). The highest your premium can be for 2020 is $491.60, but that is only if your income is above $500,000 (filing single) or $750,000 (married filing jointly). Further income breakdown of Part B IRMAA costs can be found here.

IRMAA costs also apply to your Medicare Part D premium. Part D premiums can vary depending on your plan, and the largest IRMAA increase for 2020 is $76.40 added to your monthly costs. 

As you build your retirement budget, be sure to include an ample amount for all medical-related expenses, co-pays, deductibles, and premiums. When you properly plan for healthcare costs and keep them front and center, you won’t be as surprised when you need to use them. 

Evaluate Your Current Health Needs

A lot of retirement health spending comes from ongoing medical care. It’s key to evaluate your current health — as well as your family health history — to see if any long-term issue might present itself as you age. 

Conditions like high blood pressure, heart disease, arthritis, dementia, diabetes, and osteoporosis are common in adults over 50. Knowing your individual and family conditions can give you a better sense of how much you could be spending on ongoing health needs.

Start Saving Early

As with most long-term financial goals, a proper savings strategy is critical to reaching and surpassing those goals. While you can allocate some of your assets to healthcare spending, there is one account to specifically help you save for health care expenses: a health savings account (HSA). 

The HSA was designed to help people save for healthcare costs and its benefit to retirees is undeniable. This account has three distinct tax benefits:

  1. Contributions are pre-tax
  2. Gains inside the account grow tax-free
  3. Qualified distributions are tax-free 

Since all contributions are made with pre-tax dollars, this lowers your taxable income for the year which can greatly impact your tax bill. There isn’t another type of savings vehicle quite like this. With tax benefits from start to finish, it’s a great tool to add to your retirement savings plan. 

With HSAs, it‘s important to know the type of expenses that are considered qualified. Things like prescriptions, vision care, dental needs, surgeries, nursing home care, and more are considered qualified. However, insurance premiums are not a qualified expense. Should you use HSA funds for a non-qualified expense, the IRS will issue a 20% penalty and you will be responsible for income taxes on the total distribution amount. 

To contribute to an HSA, you must first be enrolled in a high deductible health plan. This type of health plan increases the deductible and out-of-pocket expenses before insurance benefits kick in. While out-of-pocket expenses could be higher, for healthy people the benefits often outweigh the costs. 

Another key benefit of this account is funds roll over year-to-year, making it a great long-term savings vehicle. By using your HSA for long-term savings, you can prioritize health expenses while building your nest egg. 

The 2020 contribution limits are $3,500 for self-only coverage and $7,100 for family coverage. If you do qualify for an HSA, start making regular contributions. This will help amplify and prioritize your healthcare saving venture. 

Why Planning for Healthcare Costs in Retirement Matters

Healthcare costs can be enormous. It ‘s important to be prepared for those costs when they come. By creating a strong savings plan alongside an income plan for retirement, you’ll be better able to allocate expenses for future medical care. 

Healthcare costs in America have trended up for decades and don’t appear to be changing anytime soon. To live out your dreams and retirement goals, you must be prepared to prioritize your health and proper healthcare planning can do just that. 

Abacus loves exploring financial plans from a comprehensive perspective. A big part of your retirement budget will be medical costs and we want you to be ready. Schedule a time to talk with an advisor today, and expand what’s possible with your money. 


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