Health-Care Costs Often Overlooked as a Retirement Expense

Estimating how much one needs to have saved up in order to retire can be difficult. But among the most important--and most overlooked--aspects of retirement planning is health-care costs, which can have a dramatic impact on a retiree's financial picture. Allison Hoffman, an assistant law professor at UCLA, and Howell Jackson, a Harvard law professor, recently published results of a survey of more than 1,700 people ages 40-80 that asked about their expectations for out-of-pocket health-care spending in retirement. The results: More than half significantly underestimated what experts say they are likely to spend on health care once they stop working. Hoffman and Jackson discussed their findings with Morningstar.com via email.

Do you think people underestimate health-care costs in retirement because they tend to assume they'll remain fairly healthy, or are there other factors?
Estimating future health-care costs is extremely difficult. Someone must have a sense of Medicare and what it covers and doesn't cover, supplemental insurance, and the fact that some people spend well more than others, based on their insurance coverage and how much care they use. People definitely don't realize how much they might need to spend if they need extensive care. 

Past research has also shown that people don't understand the Medicare program and think it will cover more than the 60% of health-care costs than it does. Many of our respondents underestimated the costs of premiums for Medicare Parts B and D and for supplemental coverage. It also seems most people don't fully grasp how much health-care costs, including the portion they will have to pay out-of-pocket, are increasing.

To what degree were people aware of the long-term uncertainty hanging over the Medicare program and the role policy changes could play in their health-care cost planning?
Our respondents expressed moderate concern about potential changes to Medicare or other policy, but gave low estimates of how much such changes might affect their future bottom line in terms of retirement health-care spending. This finding, while important from a policy perspective, is relatively unsurprising. The difficulty that consumers face in comprehending and managing risk and uncertainty is a recurring theme in academic studies on cognitive processing and retirement planning. It offers, however, an important implication: Policymakers should aim to shape retiree health-care policy in a way that promotes financial security in light of the fact that people underestimate future spending variability.      

Your study found that women overall gave much lower estimates of their health-care costs in retirement than men did even though women are more likely to live longer and face higher costs. To what do you attribute this gender gap?
Assuming our data is representative, it is difficult to know why this gender gap exists. Our women respondents may underestimate for the same reasons that women, even college-educated women, lag behind men on measures of financial literacy and numeracy, as studies have repeatedly shown. It is also possible that women have relied on a spouse or partner for household financial management and are just less familiar with how much health care actually costs. Regardless of the explanation, women are particularly financially vulnerable in retirement if they fail to anticipate this source of significant future costs because they live longer and tend less often to have high-quality supplemental coverage from a former employer.

One might also expect to see different cost estimates based on age, income, and other demographic factors. To what degree was that the case?
One would hope, in fact, to see different cost estimates based on age, income, and other demographic factors. We saw such variation in answers from our respondents in some cases but not in others. For example, younger cohorts tended to estimate similarly to older cohorts, raising potential concerns that younger respondents may not be anticipating the increases in health-care expenditures that experts predict for the coming decades. As you noted, women respondents projected 50% lower lifetime expenditures ($30,000 median estimate of lifetime retiree spending) than their male counterparts ($60,000 median estimates) despite experts' estimates that the typical woman will spend 50% more over her retirement on health-care costs than the typical man.

In other regards, our respondents' estimates varied with demographic factors in the way experts report actual spending habits. For example, higher-income individuals tend to spend more on retiree health care. Our survey respondents seemed to be quite attuned to this effect. In the end, however, demographic factors only predict a small amount of variation among retirees; most of the variability in spending from one individual to another is uncertain.

What advice would you give nonretirees regarding how to plan for health-care costs in retirement? What factors do they need to consider?
We would recommend that most people adjust expectations upward and, those who are able to do so, plan accordingly. Perhaps even more importantly, we think that retirees need to be careful when selecting supplemental health coverage--a policy that fills in the Medicare gaps, which 90% of retirees have--that it protects them against catastrophic spending, even if they need to spend a bit more upfront.  

Although there are ways that individuals might adjust their expectations and perhaps savings behavior, our study also reveals that our current retiree health-care structures make it unnecessarily difficult for them. First, there are very few easy-to-read guides to help people (or their financial advisors) figure out likely future health-care spending. In addition, Medicare is unnecessarily complex and leaves individuals to determine how to piece together Medicare and other forms of insurance in search of financial security. Regulatory efforts could both simplify the retiree insurance maze and also, perhaps, reduce the amount of potential exposure retirees face from health-care spending in the first place.