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By Jason Stipp | 03-22-2014 11:00 AM

Get a Handle on Health-Care Costs in Retirement

Roundtable report: Get practical strategies to meet your health-care funding needs with smart use of long-term care insurance, Medigap policies, health savings accounts, and more.

Jason Stipp: Welcome back. I'm Jason Stipp, site editor for Morningstar.com, and welcome to the third panel in our Individual Investor Conference, "Get a Handle on Health-Care Costs."

Medical expenses can be one of the biggest unknown for retirees, with some estimates showing that you could spend up to $200,000 out-of-pocket in retirement for health-care costs.

So, how can we plan for such a big question mark?

I'm joined today by two great panelists to help us get our arms around this issue. We have Dr. Carolyn McClanahan. Dr. McClanahan is founder of Life Planning Partners and a member of the National Association of Personal Financial Advisors, the Financial Planning Association, and the American Academy of Family Physicians. Financial Planning Magazine named her as a Mover & Shaker in the Financial Planning Profession for her work on insurance issues, and the National Association of Personal Financial Advisors named Carolyn one of the 30 most influential people in the financial planning profession.

Carolyn, thanks for joining us today.

Carolyn McClanahan: Thanks you for having me.

Stipp: And Mark Miller is a columnist and regular Morningstar.com contributor, who writes about trends in retirement, aging, and the economy. He's the author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and Living, writes a syndicated column for Reuters, and blogs about retirement planning and saving strategies at RetirementRevised.com.

Mark, thanks for being here.

Mark Miller: Thank you, Jason.

Stipp: Let's start off with that number I mentioned at the top, $200,000. That was an estimate from Fidelity of out-of-pocket health-care costs. So, this is not all your health-care costs that might be covered by Medicare and other things. This is an out-of-pocket cost you might expect to spend in retirement. It sounds like a big figure; it's also an average price. So, Carolyn talk to me a little bit about that figure, where it's coming from and how people should think about it.

McClanahan: Well, Fidelity does this number year-to-year, and actually it's $220,000 for this year. It came down from $240,000 the year before. So that shows there has been a trend downward in health-care spending. Is that going to stick?

The problem with this number is it is an average. It does not count long-term care costs. It does not count your out-of-pocket drug costs for over-the-counter drugs. So, a lot of variables there.

But the most important thing people need to understand is because it is an average, who is really average? You think about it, and if you're a health-care consumer or if you're very unhealthy, your number might be much higher than that. Likewise if you rarely go to the doctor, they have to drag you in by the ambulance, then your health-care costs may be significantly lower.

Miller: The decrease in the number is interesting, and that forecast that they do every year at Fidelity is very much tied to Medicare trends. So, of late, it's been impacted downward in a good way by moderation in prescription-drug costs. The Affordable Care Act actually also has some cost-cutting initiatives that affect Medicare, which maybe we'll talk about later. And then the third thing that's interesting is that the Medicare population is getting younger. As boomers start to age into the post-65, the bulge is still at the young end, comparatively, for Medicare. So, they're healthier, generally.

So, those are some of the things that are driving that Fidelity number.

Stipp: Carolyn, $200,000 is a lot of money. Some folks will look at their retirement portfolio, and it might be around $200,000 in total, and they're hoping that's going to cover all of retirement.

This is a big question mark, and I think you're uniquely positioned to talk about this issue having been a physician and also financial planner. This is a big unknown, as you mentioned: my health. How do I start to figure out if am I going to need a lot more than $200,000? Am I going to need a lot less than $200,000? Nobody knows for sure, but where do you start?

McClanahan: Well, the argument that I have is we need to quit thinking of retiring at 65. We all know that was the retirement age came with Social Security back in 1934, and they picked 65 back then. If you retired at 65, you had half a chance of making it to 72. Now you're living 30 and 40 years in retirement, so people should really think about retiring early--I mean not retiring early, making sure they are maintaining their safest asset, which is their human capital.

Stipp: Which is the income that they make from continuing to work?

McClanahan: Right, their ability to work. And if you're really healthy, then you should work longer, because you don't know what's going to happen in the next 30 or 40 years.

Stipp: So, it's a way to kind of cut off some of that risk, because you're making more money upfront.

Mark with the $200,000 estimate, what kind of people in your experience are spending a lot more than that? What kind might be spending a lot less than that? Where is the variance coming from?

Miller: Well, oddly, longevity is an important factor in a way that you might not think. So, people who are sicker, tend to live less long, their lifetime spending will be less. You wouldn't call that good news, but that is a key factor.

Regional differences can be huge. So Medicare smoothes out a lot of this, because the rates and the premiums are the same nationally. But, for example, Medigap policies, which are supplemental policies that are used by people using traditional fee-for-service Medicare, the prices of those policies can vary a lot around the country.

And then you have some underlying trends in the cost of health care. So, for example, we are not talking yet about long-term care, but nursing home care is a good example where the cost of that can vary tremendously around the country. For example, New York is, I think, the highest-cost region in the country; whereas, certain other parts of the country--I know some parts of the south, for example--have very low costs.

And if you want to know about that, there is a great survey that's sponsored every year by a company called Genworth, which is one of the main sellers of long-term care, and they have a company called CareScout. They do actually an in-depth look, where you can click through an interactive map and get a look at the annual costs of different types of care in different parts of the country, and you can see huge variation.

Stipp: We are going to certainly circle back and talk about long-term care in more detail. Carolyn, you have spoken about--and written about as well--your attitude toward health care as a health-care consumer being something that you should think about as far as how much you plan for health-care in retirement. Can you talk about that a little bit?

McClanahan: To me, consumers are the biggest determinants of how much they're going to spend in health care, because two things you can do is you can make certain you're maintaining a healthy lifestyle, but the most important thing that people don't talk about is what's your attitude towards health care usage? You have some people who go to the doctor for everything from an itchy rear hand to a hangnail, and those people will use a lot of health-care dollars. So, if you know if you like to go to the doctor a lot, every time you're worried about something, you need to save more.

Likewise, I had a patient once who was 98 years old, and she said to me, I haven't been to the doctor in decades. And I asked, why are you coming now? She says my toenail is too thick to cut and I need you to use those industrial toenail clippers you guys have. That women, she is probably in the less than 10th percentile if you look in the Fidelity numbers or the EBRI numbers on health-care costs. So, know your health-care utilization pattern and plan for that.

Stipp: And this is an interesting question we got from a reader about asset allocation decisions. And readers are thinking, well, one of my big expenses might be for health care. So when I'm thinking about how I translate that back to a portfolio, does that have any direct impact on the way I might allocate my assets? So, if I expect to need a lot of money in health care, would that change my asset allocation?

McClanahan: For us and our clients, it does not, because to me, the fixed-income portion of your portfolio, that is your safety net. That's basically the money you can't lose. So you do have to calculate your health-care costs in that, and it needs to be part of your overall thing, because it's just as important to be able to eat and keep a roof over your head as it is to pay for your health-care costs.

So, overall, I think the portfolio allocation decision should be based on how much money do you have that you can take risk with.

Miller: I think about this mainly is an insurance question, but in the broadest possible meaning of the term insurance. Meaning, I would start with social insurance--Social Security. Anything you can do to delay filing, which boosts your lifetime income from Social Security, could be very, very important. As I mentioned before, Medicare smoothes out a lot of health-care costs, not all of it, but another variation can be, for example, what is your income after age 65? Because as a lot of our listeners know, there are these high-income surcharges on Medicare that kick in over certain income levels. So there is some interesting questions around managing all of those dimensions to this.

McClanahan: And that brings me to the point of …you talked about collecting Social Security as late as possible. It's important to understand your health lifestyle. I am a big proponent of using the website, Living To 100. I have no relationship with them at all, but it really looks at what's your lifestyle and how does that affect your longevity? If you are a 350-pound diabetic, age 62, and you're smoking, you probably should claim Social Security at age 62, and not wait to 70.

Miller: Yes, although there is also a spousal question there. So people need to think about this as couples. But that's a whole other topic…

Stipp: But the point what are you saying here is although health care can be an unknown in some respects, there are certain things you can control: when you take Social Security, which could provide you for more income later when you might need income for health care…

Miller: It's, how do you control against risk? For example, another thing one can have in their back pocket as a possible, I would say, last choice, but certainly an option, is a reverse mortgage.

There are ways to go if you find yourself with a large, unexpected expense. Long-term care insurance we can get to, but that's another possible strategy.

Stipp: And one of the things you had mentioned earlier about health-care costs and the variance there is location, and Mark you had written an article for Morningstar.com that dug into this issue, and it is surprising the variance that you see just from state to state.

Miller: A lot of it is hospital costs. So in a sense, when you think about retirees on Medicare, the relevance of that diminishes, frankly, because Part A of Medicare covers what it covers. So from an out-of-pocket standpoint, no. But when you look at certainly copays, and if you look at people who are retired who are younger than 65, this could be an issue. But there are huge variances in what hospitals charge for apples-to-apples services, not only from region to region, even in a region.

A lot of this reflects--and I'd be interested in your view on this Carolyn--but to me, from my reporting, a lot of its reputational. So, if you're in a big city like Chicago, we've got two or three hospital systems that are reputationally known as the top. And they've been able to get away with charging high prices for things because of that market power.

One of the things I think we're going to see as a result of the Affordable Care Act is people paying more attention to these differences when they go into the public exchanges to shop for policies, and see that policy A costs less than policy B, because policy B is with a network of these high-reputation facilities. But it's more hospitals, I believe, than it is physicians. What is your take on that?

McClanahan: Well, again, its regional variation. In Jacksonville, Fla., where I'm from, we have Mayo Clinic and the University of Florida, but our long-term care costs there in Jacksonville are $60,000 to $70,000 a year as opposed to…

Miller: $90,000 in New York.

McClanahan: No, $120,000 in New York. New York is way more expensive. So, you can have great places that are still keeping the costs relatively low. So, I think hospitals matter and location matters, too. It's just more expensive to live in the Northeast than it is in the Southeast.

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