How to plan for retiree health care costs: The Advisor and the Quant

In this series, our sister site ThinkAdvisor offers two distinct perspectives on the same topic — one from an academic, the other from a practicing financial advisor. (Check out the previous column here.)

QUESTION: How do you plan for health care expenses in retirement?

THE ADVISOR — JOE ELSASSER, CFP, PRESIDENT, COVISUM:

We’ve all seen the huge numbers associated with health care costs in retirement. When discussing these costs with clients, many find the numbers to be so large that they cause paralysis and create a barrier to making meaningful improvements to their financial plans. Health care costs in retirement can be discussed in terms of maintaining an appropriate balance between premium outlay and total cost exposure — not unlike the discussion in many other areas of the client’s life, like the decision to take a higher deductible on an auto or homeowners policy. For clients who are comfortable with greater uncertainty in their total expenditures, minimizing insurance costs will be the priority. For those who need a higher level of predictability, paying higher insurance premiums will make sense.

What are the costs to consider?

• Medicare Part B premiums: Most people pay a base premium of $134 per month for Medicare Part B doctors and outpatient coverages. Some people with lower Social Security benefits pay less, due to the “hold harmless” provision that prevents the take-home amount of a Social Security check from being reduced due to an annual increase in the Medicare Part B premium.
• Medicare Part B premiums surcharges: Some people pay more for Part B. The higher your modified adjusted gross income (MAGI) is, which in this case is equal to your adjusted gross income, plus nontaxable interest income, the higher your premium will be. For a couple with income over $320,000 in 2016, the surcharge will be $294.60 per month. In other words, a married couple with MAGI over $320,000 would pay over $10,000 for Part B costs in total, including the base premium plus the surcharge.
• Medicare Part D premiums and surcharges: Medicare drug plans carry a premium and also have surcharges based on income. The lowest premiums for 2018 are in the $15 per month range and, depending on the client needs, coverage can be as high as $200 per month. For people with incomes over $320,000 for a couple or $160,000 for an individual, the surcharge would be an extra $74.80 per month per person on top of the base plan cost.

The base costs and surcharges can add up quickly. Strategically managing what income sources are used at certain points in retirement (nonqualified, Roth accounts or life insurance) can help reduce or avoid the premium surcharges.

Base Medicare premiums and surcharges are really only a part of the discussion. Another significant cost consideration is out-of-pocket costs. Those costs include the approximately 40%¹ of total health care expenditures that stand-alone Medicare doesn’t cover, including deductibles, co-pays, and extended care. To manage the out-of-pocket costs with a minimum of premium outlay, clients should consider a Medicare Advantage plan (also known as Medicare Part C) and plan for potential extended care expenses through a reserve fund or dedicated assets. For clients less comfortable with significant out-of-pocket costs, a Medigap policy and long-term care insurance should be considered.

Ultimately, the discussion about health care costs is all about maintaining the client’s ability to reach his or her goals in terms of quality and setting of care, while paying the minimum premiums necessary to make those goals a reality, both now and in the future.

(Thanks to medicarebackoffice.com, a related company, for current premium estimates).

[1] Employee Benefit Research Institute, Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News pg 1, 2012.

THE QUANT — RON PICCININI, PH.D., DIRECTOR OF PRODUCT DEVELOPMENT, COVISUM:

The Roman playwright, Terence (c.185-159 B.C.), is credited with the Latin proverb “Ipsa senectus morbus est.,” which roughly translates to “Old age is a disease in itself.”

In 2010, a study by Anthony Webb and Natalia Zihvan of Boston College’s Center for Retirement Research estimated the average cost of health care for a couple aged 65 to be $197,000, with a 95^th percentile of $311,000, assuming they had no need for a nursing home¹. With nursing needs added to the equation, the average jumped to $260,000, with the 95^th percentile at $570,000. In 2014, Kiplinger estimated the average cost of for the same couple at $220,000². In 2017, Fidelity pegged the average cost at $275,000³. If health care costs continue to rise at the current 5% to 7% per year, the cost for a 45-year-old couple will come to around $600,000, in today’s dollars, when they reach the age of 65.

These very high costs are bad news for the majority of U.S. households approaching retirement age. According to the Federal Reserve Survey of Consumer Finances 2016 data, only 36% of the households led by a 60- to 64-year-old have a net worth north of $250,000 (48% if primary home equity is included). Only 8% of households led by a 40- to 44-year-old have a net worth greater than $600,000 (12% if primary home equity is included)⁴.

It will be interesting to see how this will unfold in the next decade. The current health care inflation rates do not seem to be sustainable without dramatic societal costs. Health care expenses have important financial, practical and moral implications for the entire U.S. population. My bet is that dramatic changes will be coming.

¹ Does Staying Healthy Reduce Your Lifetime Health Care Costs? pg 2-3, May 2010.

² A Reality Check on Health Care Costs for Early Retirees. June 2014.

³ Health Care Costs for Retirees Rise to an Estimated $275,000 Fidelity Analysis Shows. August 2017.

⁴  Survey of Consumer Finances. 2016.

Joe Elsasser, CFP, RHU, REBC developed Social Security Timing software for advisors in 2010. Through Covisum, Joe introduced Tax Clarity in 2016.

Based in Omaha, Nebraska, Joe co-authored “Social Security Essentials: Smart Ways to Help Boost Your Retirement Income.”

Renaud “Ron” Piccinini, Ph.D., came from France to America, finally settling in Omaha, Nebraska. He brings extensive experience in building world-class risk systems, supporting tens of billions of dollars in assets to Covisum. Previously, Ron co-founded PrairieSmarts, a software business. Ron wrote his dissertation on what are now known as “Black Swan Events.”