With the cost of health care just continuing to spiral higher and higher as the years go by, it becomes increasingly difficult to advise clients about how much to save to handle those future costs in retirement. On the one hand, it’s crucial not to undersave, such that ongoing health care costs devastate and deplete the retirement portfolio; on the other hand, excess conservatism can be bad too, forcing clients to unnecessarily constrain their lifestyle with more saving than is necessary, or working longer and retiring later than was actually needed. So just how much do you assume your mass affluent clients will pay in projected future health care costs during retirement?
The inspiration for today’s blog post comes from an email I received from a reader, who was struggling to decide what "reasonable" assumptions would be for projecting health care costs in retirement. Her approach – which I have seen many other planning firms use as well – was to project health care costs separate from all other retirement costs, specifically so that a higher inflation rate could be attached to the health care expenses. Her assumptions? 3.5% for general inflation, and 8% for health care costs.
As the saying goes, trends that can’t continue forever, don’t. At some point they end. And I have to admit, I think our inflating health care costs fall into this bucket. After all, a spread of 8% health care inflation and 3.5% general inflation leads to some pretty wacky results when projected over a multi-decade period of time. Eventually health care begins to crowd out other parts of the economy. In the long run, the only jobs we’d all have is providing health care services to each other, as that portion of expenditures – nationally – would eventually consume the overwhelming majority of the household budget. And that’s just not realistic in my opinion; from the lack of financial viability of Medicare, to the direct household impact, health care costs just cannot inflate indefinitely at these kinds of levels. At some point, it just becomes unaffordable for everyone, and the system must change.
On the other hand, it’s also worth noting that for most retirees, especially those "mass affluent" or wealthier with some retirement asset base, the driving cost of retirement health care costs isn’t really the cost of underlying care, per se; it’s the cost of the insurance that covers it. After all, most retirees are not paying raw health care costs out of pocket; they’re covered by Medicare, and what they’re paying for is Medicare Part B, a Part D prescription drug plan, and some co-pays and costs that slip through the cracks (or a MediGap supplemental policy to cover those, too). Thus, in essence, the "cost of retirement health care" for most retirees probably looks more like the cost of Part B + Part D + MediGap supplemental insurance, and whatever the cost of that coverage inflates at over time.
For instance, a married couple who earns less than $170,000/year of income will pay up to $115.40/month/person for Medicare, or a total of $115.40 x 2 x 12 = $2,769.60/year. We’ll assume a general Part D policy for the couple costs $75/month/person, and a reasonable MediGap supplemental insurance policy costs $200/month/person, for a total annual cost of $1,800 and $4,800, respectively. At this point, we’re at a total cost of $9,369.60/year, but the MediGap policy should cover the overwhelming majority of any remaining co-pay and co-insurance amounts, leaving very little if any out-of-pocket costs from this point forward.
Now I’ll grant that almost $10,000/year is not cheap. And for families living on a limited, fixed income, this can be a crushing cost (and most likely, such families will spend only about half this amount, forgoing the MediGap policy or buying a much less expensive "bare bones" version, and retaining some of the remaining risk). But at the same time, for those with some level of additional savings and a reasonably comfortable retirement, these are not catastrophic costs to the retirement plan. And because virtually all medical costs have been insured at this point (although long-term care costs are another story), there’s little uncertainty left (aside, perhaps, from the inflation rate on insurance costs, as mentioned earlier).
But insurance costs – at least, for Medicare – aren’t inflating anywhere near 8%. In fact, due to the flat no-change cost-of-living adjustments for Social Security benefits in recent years, some people are still paying the $96.40/month/person Medicare Part B premiums from two years ago! Insurance premium inflation has been 0% for these people!
So the bottom line is that while the cost of health care is a serious issue to contend with, I’m skeptical of the idea that health care costs will just spiral upwards forever at levels significantly higher than general inflation, such that it overwhelmingly consumes the budget of the average mass affluent retiree. Not only is that not sustainable, but when viewed from the perspective of the cost of Medicare and other insurance, that doesn’t seem to be entirely happening even today. Granted, Medicare itself may go through some significant changes in the future, as its sustainability is questionable as well. But indirectly, that just makes the point again – health care costs that inflate excessively can’t go on forever. It can’t, so it won’t.
So what do you think? How do you handle projecting health care costs for your retired clients? Do you separate out health care costs in the retirement analysis, or just include it as part of the overall package? Do you look at the costs of health care itself, or the costs of the insurance it takes to protect against those costs?