Retirement Health-Care Costs: The Swing Factors

Note: This article is part of Morningstar’s October 2014 5 Keys to Retirement Investing special report. This article originally appeared Aug. 8, 2014.

For many of us who are still working, the thought of retirement conjures up images of dream vacations, golf, and perhaps more time spent with family or pursuing long-neglected hobbies. As evidence, look no further than the many TV and print ads aimed at retirement savers released by financial firms that show robust gray-haired 60-somethings frolicking on a beach, self-satisfied looks on their faces. This retirement ideal may represent what many of us hope to find in our golden years, but the reality is likely to be rather different. In fact, these ads often fail to mention one of the most significant of all retirement expenses--health care.

Whether retirement is more than a decade away or right around the corner, most of us have little idea how much we'll need to have saved up to cover health-care costs once we stop working. Some assume that Medicare will cover most if not all of their expenses. But while Medicare helps cover costs such as doctor's visits, hospital stays, and prescription drugs for many seniors (depending on the plan or plans selected), it doesn't cover everything. In fact, in 2010, Medicare covered just 62% of all health-care expenses for those age 65 and older enrolled in the program, according to numbers from the Employee Benefit Research Institute (EBRI). Another 12% was paid out-of-pocket, while 13% was covered by private insurance and the remaining 10% from other sources.

A $220,000 Challenge
Fidelity estimates that the average 65-year-old couple retiring this year will need $220,000 to cover health costs in retirement. (The estimate is based on today's dollars and assumes the couple relies on Medicare for health insurance. It includes the cost of deductibles and coinsurance as well as premiums and out-of-pocket drug costs for prescription drugs; it does not include costs for long-term care, over-the-counter medications, or most dental costs.) The good news is that this figure is down from its peak of $250,000 in 2010. The study attributes this drop in part to Medicare changes that have reduced out-of-pocket drug costs for seniors as well as demographic changes as more Baby Boomers retire, pushing the average retiree age lower and thus lowering health-care costs as well.

But even if health-care costs for seniors aren't growing as rapidly as they did previously, they still are climbing. The fact remains that for many of today's seniors--and tomorrow's--health care will have a profound impact on their personal finances in retirement, not to mention their quality of life.

How Much Will You Need to Have Saved Up?
So, how can those who are still in retirement-savings mode anticipate how much they'll need for health care once they stop working? There's no way to know for certain, of course. To get an idea, you could use an online health-care calculator that helps you estimate these future costs, such as the one provided by the AARP, which takes into consideration variables such as the individual's current age, height, weight, and any ongoing health problems.

No calculator can tell you definitively how much you'll need to save for health-care costs later in life, but experts say there are several key swing factors to take into consideration--some of which can be controlled and others that can't. These swing factors include the following:

Your Health Profile: If you currently have a chronic health issue that requires ongoing medical treatment, it may translate into higher health-care costs in retirement. But managing the condition could be key to avoiding even higher costs down the road.

Dr. Carolyn McClanahan, a physician and founder of Life Planning Partners, a financial planning firm based in Jacksonville, Fla., says high blood pressure is a good example. "If you do a great job of taking care of your blood pressure your life expectancy is the same is anyone else's," she says. "But if you do a poor job of taking care of your blood pressure, you are at risk of heart disease and stroke." McClanahan, who participated in a panel discussion on health-care costs in retirement at Morningstar's Individual Investor Conference in March (click here to watch the video), says that obesity "is actually the biggest and most expensive health condition because that sets you up for so many other things."

Your parents' health conditions later in life may offer other clues as to what your own health costs will be, she adds. But don't assume that just because your parents have health problems in their old age that you will, too. McClanahan says lifestyle plays a role as well, and that children who live differently from their parents--getting more exercise and eating better, for example--may have fewer health problems than mom and dad.

Your Life Expectancy: Maintaining good health in retirement should be a goal for any senior, but doing so could have unanticipated effects on your finances. Anthony Webb, a senior research economist at the Center for Retirement Research at Boston College, says the healthier you are, the higher your potential health costs in retirement. That's because healthier people tend to live longer lives and, therefore, must bear health-care costs for a longer period of time than the less healthy. And despite better overall health, they are not immune to the high costs that typically come with end-of-life care. "The only difference between the healthy and the apparently sick is when that expensive period occurs," he says.

A study Webb co-authored for the center found that among households turning age 65 in 2009, those in which members were in good health could expect to pay an average of $260,000 (in 2009 dollars) in health-care costs over the rest of their lives while those that weren't in good health could expect to pay $220,000. (Webb points out that, since 2009, health-care costs have not been rising as rapidly as they had been when those numbers were calculated.) The gap was even greater among outlier households, with healthy households that incur the highest health costs (meaning those in the 95th percentile of expenditures for the group) expected to pay $570,000 over the remainder of their lifetimes and those at the high end of the spectrum among nonhealthy households (95th percentile of the group) expected to pay $465,000. (You can read the study here, and you'll find tips on estimating your own life expectancy here.)

Your Gender: Another factor that comes into play when examining the relationship between longevity and health-care expenses is gender. Because women tend to outlive men, they often end up paying more in insurance premiums and other health-care costs in retirement, according to a report by EBRI. The report includes estimated health-care costs (including Medigap or supplemental insurance, Medicare Part B and Part D premiums, and out-of-pocket drug costs) for men and women, age 65. Among those reaching age 65 in 2013, men would need to have saved $65,000 and women $86,000 in order to have a 50% chance of having enough to cover the median amount of health-care costs in retirement, the report estimates. Among those in the 90th percentile of health-care expenses in retirement, estimated costs were much higher, with men needing $96,000 and women needing $124,000 to have a 50% chance of covering all expenses. (The EBRI study uses a different methodology than the Fidelity study and is based on a wide range of possible life expectancies; the Fidelity estimate is based on an average life expectancy of 82 for men and 85 for women.)

Your Geography: Not only when you retire but where you retire can help determine what you'll pay for health care later in life. As Morningstar columnist Mark Miller explains in this article, health-care costs vary from region to region--sometimes greatly--in particular, the cost of Medigap policies and nursing-home care. For example, according to a survey of long-term care providers, the median cost of one year at a nursing home in New York is $130,670 while in Utah it's just $73,000 (both figures are for a private room). If you plan to live in an area where health care is more expensive, you'll need to budget more of your retirement savings for this goal.

How You Use Health Care: McClanahan says another key factor to keep in mind is how you use the health-care system--what she calls a person's "health care usage mindset." Are you the type of patient who makes an appointment every time you feel a cold coming on? If so, then you probably want to budget for higher health-care costs in retirement. Then, there are those who have to be dragged kicking and screaming to the doctor and who may not need to save as much, she says. "You have people out there who go to the doctor for everything," she says. "If you know you like to go to the doctor a lot, then you need to plan for higher health-care expenses."

This issue also comes into play when thinking about end-of-life care, McClanahan says. Some people believe that all measures--no matter how costly--should be taken to extend their lives to the greatest length possible while others would prefer not to prolong any potential suffering or to risk depleting their assets in what could prove to be a futile effort. One way to begin contemplating your own end-of-life financial needs is to think about what you'd do if your doctor told you that you had developed a form of cancer that was likely to be fatal within a short time span. Would you be more likely to enter hospice care or pursue multiple treatment options that could rack up significant costs? If it's the latter, you'll need to save more, McClanahan says.

The High Cost of Dementia: While living a long, healthy life is a worthy goal, McClanahan and Webb both say, longevity can have a downside if a person develops dementia. Webb says those who develop Alzheimer’s often end up in nursing homes and may remain there for years. The problem is that patients with dementia may otherwise be relatively healthy but unable to care for themselves, requiring near-constant care that is both costly and which can last for more than a decade.

For this reason and others, McClanahan says it's essential that those approaching retirement age make their loved ones aware of their health-care wishes in case they one day are no longer capable of making decisions for themselves. "People talk about long-term care insurance, but you really need to think more about a long-term care plan," she says. She suggests thinking now about what will happen if you require full-time care in your later years. If you have family that will help with your care, make sure that everyone understands what is expected--though "some people don't realize how difficult it can be," McClanahan says. She also recommends thinking about where you would want to live should you develop dementia. If you plan to stay in your home and will need to pay for an aide, it could end up costing considerably more than a nursing home. McClanahan suggests asking yourself the question: "Are you willing to spend down your assets to cover that?"

So, What Can You Do?
What are your options if you're at high risk for some of these swing factors? Try to save even more for retirement, McClanahan says. She advises younger retirement savers to sock away as much as possible for retirement while urging those in their 50s or older, in particular, to spend time focusing on potential health-care costs.

"There's merit in aiming to save as much as you can, but not earmark it for particular purposes," says Webb. He says this may mean dipping into money earmarked for a child's or grandchild's college or other savings to cover health costs, if necessary.

Webb says that the costs of Medicare and Medigap insurance, while rising faster than the overall rate of inflation, are fairly predictable. The wild cards for retirees, he says, are copays and nursing-home costs. Even so, Webb says he is ambivalent about the value of taking out long-term care insurance. "The problem with long-term care insurance is that it's really not a very good product," he says, citing high premiums that make it unaffordable for many. Those who can afford it may well be able to pay for long-term care out-of-pocket, he adds. Others favor long-term care insurance for the peace of mind it provides. Mark Miller offers buying tips for those considering long-term care insurance here while Christine Benz, Morningstar's director of personal finance, provides a crash course on long-term care here.

In some cases, even saving diligently might not be enough. "It's simply not possible for most individuals to save enough money if the 99th percentile of lifetime health-care costs occurs," Webb says. "The reality is that a significant number of people... as a result of high health-care costs end up in Medicaid."

Depressing as that may sound, the good news is that there are proactive steps that can be taken now to improve one's odds of managing retirement health costs. Getting enough exercise, eating right, and staying on top of any chronic health problems are obvious places to start. Others include reviewing your retirement-savings rate and projections regarding how much you'll need in case health problems do arise later in life. You might also consider investing in a health savings account (provided your employer offers one as part of a high-deductible health-care plan), which can serve as a hedge against high health-care costs in retirement. And don't discount working longer, if possible. It could help you delay tapping your nest egg, thus making it last longer.

Finally, as you approach your senior years, don't be afraid to discuss with loved ones how you'd like the later stages of your life to play out. Would you want life-sustaining measures taken if you become incapacitated? Where do you want to live if you develop dementia? Answering questions like these and communicating the answers to those who would make decisions in your stead is essential for anyone, regardless of what your retirement health-care picture looks like.