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Estimating Health Care Costs in Retirement

Health care costs are probably the biggest source of anxiety for those unsure if their retirement nest egg is big enough.

A 2010 study by Fidelity suggested that a 65 year old retiring couple will need about $250,000 to pay health care expenses in their lifetime (more than 50% higher than their 2002 estimate). This assumes the couple does not have employer provided coverage, but does qualify for Medicare. It does not include long term care or most dental services.

The Employee Benefit Research Institute suggests that $376,000 is required to have a 90% chance for this couple to pay all their health care costs. A study by Boston College also showed the 95th percentile at about 50% more than the median.

This is actually good news for planning purposes, because it means that the extremes are not that far away from the averages. Of course there will be some people who will have astronomically high costs, but for over 90% of the people, the total cost will be within about 50% of the median. Half will obviously be lower.

The Fidelity study found that average monthly health care costs are $535 a month, which was about 20% of average total spending. Other research tends to support this, with average out of pocket costs usually reported at around $7,000 per year. This varies by age.

Interestingly, most Americans don’t have $250,000 in total savings, let alone set aside just to pay for health care. Presumably, that means they simply don’t purchase or receive all of the care that they would if they had more money. It is unclear if this means they tend to suffer more health problems or die earlier. But most people who have the ability to save meaningful assets will not want to skimp on health care.

The other key take away from the Boston College study is that expected costs don’t go down that much as people age. In other words, an 80 year old couple has only about 20% less expected total future cost than a 65 year old couple and even a 90 year old couple still has over half of the expected total cost ahead of them.

This means that most health care costs in retirement come in the last few years of life. This may not be a surprise, but it is very important for planning. It should not be assumed that health care expenses will be consistent over retirement so the money allocated for it should not be considered a windfall if it is not spent early. This may be the reason many people spend down their assets more slowly than a straight line pattern.

Bottom Line: Most people entering or already in retirement, unless they have unusual circumstances, should plan on spending about $250,000 for health care expenses, maybe more. The bulk of this will probably come toward the end of life.

The good news about this is it gives more time for assets to grow to meet the expense. On the other hand, health care inflation has consistently been running faster than basic inflation.

Our Personal Strategy investment portfolios are designed to adapt to the current reality of where individuals stand in relation to their retirement goals. Part of this requires estimating health care costs. Our base assumption is that the excessive inflation rate of health care will revert to a more normal rate, though we believe it is prudent to hedge this by assuming costs greater than the median.

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