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How to Plan for Healthcare Shocks in Retirement

How to Plan for Healthcare Shocks in Retirement

Christine Benz: Hi, I'm Christine Benz for How do healthcare shocks affect retiree spending? Joining me to share some research on that topic is David Blanchett. He is head of retirement research for Morningstar Investment Management.

David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: David, the retirement planning community is increasingly thinking about the role that healthcare costs play in retirement planning. Let's talk about the latest data runs. I know Fidelity annually puts out some data about healthcare spending for couples who are age 65. What does that look like in aggregate?

Blanchett: It's pretty scary. Fidelity says about a quarter of a million dollars, is the cost of healthcare …

Benz: Yeah, even higher, I think.

Blanchett: Right. Others will say up to, say, $400,000. If you just look at healthcare, medical expenses in retirement, it's a pretty scary number.

Benz: The thing is though, when you look more closely, you see that these healthcare costs vary hugely by households. Some households have giant out-of-pocket outlays and some households have less. How should retirees approach that fact?

Blanchett: Most healthcare expenses are quite known. Things like Medicare premiums. I think the scary item is things like nursing home stays or home health stays--things that require this significant, unexpected out-of-pocket cost, and that's really hard to plan for. So, when I think about things like that, I often think that maybe home equity is the asset of last resort should that event occur.

Benz: Let's talk about how these costs can affect retiree spending. Certainly, if you have some big healthcare shock, that has implications for your overall spending. But I guess the thing you examined in the paper was whether it had repercussions for spending in other parts of the budget. What did you find?

Blanchett: The question I looked at was, if you have a household that experiences a health shock--this is not going to be a Medicare premium, it's an unexpected health expense--what happens in the future? Does that household, if you compare future expenditure, spend less needed before the health shock or less. Because in theory, maybe expenses rise because they have additional health expenses, maybe they fall because they kind of adapt.

What I find is that the larger the expense, the more future expenses fall in retirement. And what we are seeing then is that households adjust their spending based upon this expenditure. To me, it just suggests this idea that households experience this large health shock and then spend the same or more in the future doesn't tend to hold at least on average.

Benz: So, the question is, are households that experience the healthcare shock reining in spending because they want to or because they have to because they feel the budget crunch?

Blanchett: So, that's a great point. If you look at different types of spending--you can look at total spending or discretionary and nondiscretionary--where you see almost all the reduction is in the discretionary spending. There wasn't a significant reduction in nondiscretionary spending. You have to pay a mortgage, you have to pay for other things. But in those areas, you can control spending, that's where it declined the most.

Benz: This follows on some research that you had done more broadly about retiree spending where you actually looked at trends over the retirement life cycle and found that across different income bands, even for people who had great financial wherewithal, you did find some tapering off in spending toward the middle part of retirement, is that right?

Blanchett: That's right. And so, what's interesting is, again, this was the same data set--almost every household, about three fourths of the households had lower consumption in today's dollars over time. It was those households that had the higher shocks that even reduced by more.

Benz: And that's where you wound up with that what you call the retirement spending smile--higher early on, sort of tapering off and then back up, but only for some households.

Blanchett: But if you can live that long, that's right.

Benz: The question is, if I'm a retiree attempting to get my arms around this issue and factoring in healthcare expenditures, potential shocks in my plan later in life, how do I do that? How do I embed some safeguards in my plan to guard against these big healthcare shocks?

Blanchett: There's no easy answer to that question.

Benz: You mentioned home equity though.

Blanchett: I would say that home equity is one. I'd say to me a bigger issue here is, those numbers that come out by Fidelity and others, they are good to know, but they are really scary. My perspective is, we don't calculate the value in today's dollars of what your food is going to cost, what your home is going to cost, what your education--whatever you are spending money on is going to cost. To me, healthcare is one part of a much larger puzzle. And if you have a healthcare expense, if it goes up, you can usually spend less somewhere else. I'm not saying don't worry about it, but view consumption when you are spending collectively and then have things like home equity when things happen to pay for those things as they come up.

Benz: I guess, another point is that healthcare expenses aren't a brand new cost for most of us in retirement, that we've been shouldering them, but maybe through our paycheck deductions while we are working. It's not this brand new cost that we never had before.

Blanchett: Right. One thing that I think is really uncertain is what will happen 20 years from now. I think that we have a pretty good handle on where Medicare premiums would go in maybe next year. But there is this uncertainty, what will happen if healthcare costs keep rising by 7% a year. I don't know how to answer that question either. But that is something you just need to be aware of for someone thinking about, well, how much do I save for retirement, how do I save for retirement. That's where things like HSAs are valuable because it can help someone prepare for retirement in a tax-advantaged way to help fund those healthcare expenses.

Benz: You mentioned inflation, I guess, that also calls for embedding some inflation protection into my portfolio plan as well, right?

Blanchett: Right. Assets that track inflation better, like TIPS or real estate, really are more attractive investment options for someone who is in retirement versus someone who is, say, much younger.

Benz: Great research, David. Thank you so much for being here to discuss it with us.

Blanchett: Thank you.

Benz: Thanks for watching. I'm Christine Benz for

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About the Authors

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

David Blanchett

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David M. Blanchett, Ph.D., CFA, CFP®, is head of retirement research for Morningstar’s Investment Management group. In this role, he works to enhance the group’s consulting and investment services. He conducts research primarily in the areas of financial and tax planning, annuities, and retirement plans. Blanchett also serves as the chairman of the Advice Methodologies subcommittee, which is the group responsible for developing and maintaining all methodologies relating to wealth forecasting, general financial planning, automated investment selection, and portfolio assignment for Investment Management. Before joining Morningstar in 2011, he was director of consulting and investment research for Unified Trust Company’s retirement plan consulting group.

Blanchett’s research has been published in a variety of academic and industry journals, such as Financial Analysts Journal, Journal of Financial Planning, The Journal of Portfolio Management, Journal of Retirement, and The Journal of Wealth Management. He has also been featured in a variety of media outlets and publications, including InvestmentNews, MarketWatch, Money, The New York Times, PLANSPONSOR, and The Wall Street Journal. His research has won a number of awards, most recently the Journal of Financial Planning’s 2014 and 2015 Montgomery-Warschauer Awards, the Financial Analysts Journal 2015 Graham & Dodd Scroll Award, and the CFP Board Center for Financial Planning 2017 Academic Research Colloquium Best Investments Paper Award.

In 2014, InvestmentNews included him in their inaugural 40 under 40 list as a “visionary” for the financial planning industry, and in 2014, Money named him one of the brightest minds in retirement planning. He is a RetireMentor for MarketWatch and an expert retirement panelist for The Wall Street Journal. Blanchett is also on the executive committee for the Defined Contribution Institutional Investment Association (DCIIA) and serves on the editorial boards of Morningstar Magazine and the Journal of Retirement.

Blanchett holds a bachelor’s degree in finance and economics from the University of Kentucky, a master’s degree in financial services from The American College, a master’s degree in business administration from the University of Chicago Booth School of Business, and a doctorate in personal financial planning from Texas Tech University. Blanchett holds the Chartered Financial Analyst®, Certified Financial Planner™, Chartered Life Underwriter (CLU®), Chartered Financial Consultant (ChFC), and Accredited Investment Fiduciary Analyst™ designations.

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