Healthcare Costs in Retirement

by Warren Seah

Healthcare costs are becoming a larger burden on retiree budgets as time goes on. These expenses tend to rise at a rate higher than inflation, which raises the question: should healthcare expenses be allocated their own dedicated portion within a retiree’s portfolio?

The Importance of Carving Out Funds

According to Fidelity’s 2023 Retiree Health Care Cost Estimate, a single 65-year-old retiring this year should plan to save an average of $157,500 specifically for healthcare and medical expenses throughout retirement. For couples, this amount increases to $315,000. It’s important to note that this estimate assumes the remaining balance will be invested and earn a low return. It includes standard Medicare premiums, deductibles, and coinsurance, but excludes over-the-counter medications, most dental care, and long-term care.

Creating a Dedicated Healthcare Bucket

A dedicated healthcare bucket can take various forms, such as a health savings account, an individual retirement account, or a taxable brokerage account solely designated for healthcare expenses.

The Rising Nature of Healthcare Costs

While healthcare costs may initially seem reasonable in the early stages of retirement, they tend to increase at a rate of 1.5 to 2 times the consumer price index (CPI). In recent years, this growth has been moderated due to the long-term nature of healthcare contracts. However, experts anticipate that medical costs will revert to or even exceed trend levels in the years to come.

Aging and Increased Healthcare Consumption

It’s not just the rising costs of medical services that contribute to higher expenses throughout retirement; it’s also the fact that older adults typically require more healthcare as they age. Research conducted by David Blanchett, now the head of retirement research for PGIM DC Solutions, indicates that the median household allocates 10% of total expenditures to healthcare at age 65. This percentage doubles to 20% by age 85.

Planning Beyond General Inflation

If retirees only budget for general inflation, they may not be adequately prepared for the escalating healthcare costs in retirement. A common approach to calculating retirement expenses is to tally up current expenses and apply a standard 2% or 3% inflationary increase each year. However, this approach may not account for the specific challenges posed by rising healthcare expenditures.

In conclusion, as healthcare costs continue to grow, it is crucial for retirees to carefully consider how they allocate funds specifically for healthcare in their retirement portfolio. By doing so, they can better plan for the inevitable rise in these expenses and ensure their financial well-being throughout retirement.

A Better Approach to Managing Healthcare Expenses

Some experts are advocating for a different approach when it comes to managing healthcare expenses. Rather than relying on a general investment account, there is a growing consensus to set up a dedicated account specifically for healthcare costs. According to Ron Mastrogiovanni, CEO of HealthView Services, having a dedicated healthcare account brings a sense of peace of mind.

HealthView Services has recently introduced a new product that helps financial advisors assess and manage retirement healthcare costs for their clients. This software takes into consideration various factors such as an individual’s health status and location to estimate personalized expenses. It then suggests investment strategies based on the retiree’s risk tolerance and needs. When retirement arrives, the software automates withdrawals from the account for healthcare expenses, making adjustments as needed due to changes in health status, healthcare policies, and other relevant factors.

The dedicated healthcare account can be set up alongside a health savings account (HSA). HSAs are tax-advantaged accounts specifically designed for healthcare expenses, both in the present and future. However, despite their benefits, HSAs may not be sufficient to cover lifetime healthcare costs for individuals, even for those who have been contributing to them since their inception less than 20 years ago.

Not everyone is convinced that having a separate healthcare account is necessary. Michael Blanchett, a researcher in the field, acknowledges the concept but notes that money is fungible. His research suggests that as healthcare expenses increase during retirement, other discretionary spending decreases. Travel and other non-essential expenses are often sacrificed by retirees facing health challenges.

On the other hand, some families prefer to create a separate account specifically for potential long-term care expenses. Carolyn McClanahan, founder of Life Planning Partners in Jacksonville, Florida, recommends buying a hybrid life and long-term care insurance policy to help segregate funds for this purpose.

McClanahan, who is also a medical doctor, takes a different approach and incorporates healthcare expenses into her clients’ regular budgets. She believes that by integrating healthcare costs into the overall financial planning, individuals and families can better prepare for their healthcare needs in retirement.

In conclusion, while there is no one-size-fits-all approach to managing healthcare expenses, the idea of having a dedicated account specifically for healthcare costs is gaining traction. It offers peace of mind and allows for better financial planning in retirement. Whether it’s through a dedicated healthcare account or integrating healthcare expenses into the regular budget, the goal is to ensure that individuals are prepared for the financial challenges that may arise during retirement.

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