How to Plan for Medical Expenses in Retirement

A key aspect of retirement planning is anticipating how your spending habits may shift in your later years. Your housing costs, for example, may decrease if you plan to downsize, but there are other expenses you may dedicate a larger share of your retirement assets to.

Health care can be one of the biggest expenses. According to Fidelity Investments, a 65-year-old couple retiring in 2018 would need $280,000 to pay for medical expenses in retirement. That doesn’t include the additional cost of long-term care, which has a median annual cost of $89,297 for a semi-private room in a nursing home. 

Despite saving and preparing for retirement for their entire lives, many retirees aren't mentally or financially prepared for these expenses. A survey by HSA Bank found that 69% of adults aged 65 and older believed they’d need less than $100,000 for health care.

“Retirees, in addition to most consumers, seem to underestimate how much they will need for health expenses in retirement, including premium and out-of-pocket costs,” says Chad Wilkins, president of HSA Bank.

If you’re nearing retirement or you’re already making the transition out of the workforce, it’s important to understand how to plan for the possibility of growing medical costs.

There are two important numbers to understand as you plan for health care expenses in retirement: how much money is coming in and how much is going out.

The typical 65- to 74-year-old has an average household savings of $358,400. On average, those 65 and older spend $3,800 per month and receive 51.3% of their pre-tax income from Social Security. As of September 2018, the average monthly Social Security benefit for retired workers was $1,417.22. 

How much of your retirement income you need to budget for health care depends largely on your age and your overall health.

“The healthier we are going into retirement typically means that less money will be allocated toward health care expenses,” says Chris Schaefer, head of the retirement plan practice at MV Financial in Bethesda, Maryland. “However, the other side of that coin is that with a healthier lifestyle, life expectancy will be longer and therefore, retirees need to plan for a longer time in retirement.”

In other words, you may not spend as much to manage chronic or serious illnesses if you remain healthy. But, living longer means a longer time frame for spending on health care and a potentially greater need for long-term care as you age.

Medicare can pay for some of your health care spending in retirement, but it has limitations, says Michael Gerstman, CEO of Gerstman Financial Group, LLC in Dallas, Texas.

“For example, without a Part D prescription drug policy, Medicare does not cover medications,” Gerstman says. If you have Original Medicare, meaning Parts A and B, that won’t cover dental and vision care, but Medicare Advantage plans typically do. No part of Medicare offers coverage for long-term care.

If you’re relying on Medicare to help cover medical expenses in retirement, it’s important to plan for your deductibles, premiums and out-of-pocket costs. For 2018, the standard deductible for Medicare Part A was $1,340. The standard monthly premium for Part B was $134, although this could be higher, based on your income. The base premium for Part D coverage was $35.02 per month.

Medicare Advantage plans are offered through private insurers. As a result, they set the premiums, not the federal government as with Parts A, B and D. Depending on who you get coverage through and what your policy covers, you could pay more or less for a Medicare Advantage plan.

Climbing health care costs don’t have to drain your nest egg if you’ve planned ahead. There are two ways pre-retirees can create a safety net for health care spending in retirement.

The first is utilizing a Health Savings Account (HSA) if you have access to one. These accounts are available with high deductible health plans and offer triple tax advantages: tax-deductible contributions, tax-deferred growth and tax-free withdrawals for qualified medical expenses.

“HSA funds can be used to pay for certain medical premiums, including Medicare premiums, and long-term care insurance premiums,” Wilkins says. If you’re already in your 50s, you can still maximize these plans by taking advantage of catch-up contributions and employer contributions.

“Individuals who are 55 or older can make a catch-up contribution of $1,000 per year in addition to the maximum contribution limit,” Wilkins says. “Many employers will contribute cash rewards to an HSA for preventative screenings like mammograms or an annual physical.”

For 2018, the regular contribution limit is $3,450 for individual coverage and $6,900 for family coverage. Those limits apply to both employee and employer contributions combined. There is a caveat, however. Once you enroll in Medicare, you’re no longer able to make new contributions to an HSA.

Purchasing long-term care insurance is a way to fill the gap left by Medicare. This type of policy can pay a monthly benefit towards long-term care for a two to three-year period.

That can allow you to avoid having to spend down assets to qualify for Medicaid, which does pay for long-term care. But, long-term care insurance premiums may not be affordable for everyone. Gerstman says an alternative is buying a life insurance policy that allows you to add on a long-term care insurance rider.

“This allows younger people to get ahead in their long-term care planning,” Gerstman says. The sooner you buy life insurance and/or long-term care insurance, the lower your premiums are likely to be.

Health care spending can easily account for a big share of your retirement budget. Taking time to estimate those costs and create a strategy for spending can allow you to preserve more of your retirement assets for other expenses.