A Reality Check on Health Care Costs for Early Retirees
When you draw up a retirement spending budget, you’re likely to account for utilities, car insurance and lawn care. But have you given the cost of health care a hard look, or are the numbers too scary to contemplate? Once you get real about those expenses, you may want to delay your targeted retirement date by a year or so.
On average, a couple retiring at 65 can expect to spend $220,000 on health care costs during retirement -- and that does not include long-term-care costs, according to new estimates by Fidelity Investments. That number remains unchanged from last year, but it’s still a sobering figure.
This year, Fidelity added a new twist to its calculations. The firm estimates that the average couple who retire at age 62 can expect to spend $17,000 a year on out-of-pocket health care costs until they enroll in Medicare. Those costs would include the premiums for policies the couple would need to buy on the individual insurance market once employer-sponsored coverage ends, as well as co-payments, deductibles and other costs. This average does not take into account any tax subsidies the couple could receive on the state-based exchanges under the Affordable Care Act.
Those contemplating early retirement should consider those costs before taking the leap. If you’re planning to keep your insurance under COBRA after you leave your job, the costs won’t be much different, says Sunit Patel, senior vice-president of Fidelity Benefits Consulting. The $17,000 estimate helps people “gain insight” on the costs of retiring before Medicare kicks in. Fidelity also estimates that a couple could save $10,000 for each year they delay retirement until age 67.
Here are some strategies you can employ to ease the pain of health care costs in retirement.
Create a budget. Once of the most important moves for pre-retirees is to “make sure that their financial plan explicitly accounts for health costs in retirement,” Patel says. When preparing a budget, include a line item for health care. Some costs are relatively fixed, such as Medicare premiums. Remember inflation, which tends to rise faster for health care than the general inflation rate.
Also be prepared for unexpected spikes in costs, such as a $10,000 dental bill. Medicare does not cover dental or vision care. Nor does it cover long-term care. Be sure to set aside a large emergency reserve that you will not include when you calculate your monthly retirement expenses.
Fill in the gaps. If you’re going with traditional Medicare, buy a private medigap supplemental insurance policy. These private plans will cover many of costs that Medicare does not cover, such as deductibles and co-payments, and will reduce the volatility of your health care costs. Expect to pay about $150 a month, depending on the plan and the region. You can save money on premiums for these plans by choosing a higher deductible.
Go with Medicare Advantage. These private insurance plans tend to be cheaper overall than a combination of traditional Medicare, a Part D plan and a medigap supplemental insurance policy. Currently, 30% of all Medicare beneficiaries are enrolled in an Advantage plan, compared with 16% in 2006, according to the Kaiser Family Foundation. And since the passage of the new health care law, all plans must limit beneficiaries’ annual out-of-pocket spending to no more than $6,700 -- a feature that offers a level of predictability for retirees looking to calculate their costs. You can compare costs and coverage of medigap and Advantage policies offered in your area at Medicare.gov and PlanPrescriber.com.
Buy an annuity. If, after you create your budget, you discover that you’ll likely need additional income, you can buy an annuity to fill in part of the shortfall -- perhaps for Medicare premiums. One option is a deferred fixed annuity. You figure out how much you’ll need at some point in the future, and you hand over a lump sum to an insurance company. You’ll get lifetime monthly payments after your start date.
Say you’re 60 and you figure you’ll need $400 a month to cover some out-of-pocket costs starting at age 65. You’d pay $64,000. If you don’t need the payouts until age 70, your cost would be $44,000.
Some insurance companies are offering annuities with special health-related features. For example, Liberty Mutual offers a rider on its Freedom Series Builder deferred annuity that allows you to withdraw money without paying surrender fees if you or your spouse becomes seriously ill. Expect to pay extra for this feature, however.
Tap life insurance. Most permanent life insurance policies allow you to take partial withdrawals or policy loans to pay for health care and other expenses. If you take a withdrawal or don’t pay back the loan, you reduce the death benefit for your heirs. With many policies, you can also accelerate your death benefits if you are diagnosed with a terminal illness.
Cut your health care spending. Be sure to take advantage of free services. Under the Affordable Care Act, Medicare offers free coverage for 20 preventive services, including an annual wellness exam; screenings for colorectal, prostate and breast cancer; and flu vaccines. Your private plan on the individual market may also offer free services and incentives to stay healthy.
If you’re an early retiree buying coverage in the individual market, you can save a bundle by sticking with in-network providers. You may need to pay the full costs -- or at least a higher co-payment -- if you seek care outside your plan’s provider network.
Sock away cash. A large number of private plans on the new exchanges are high-deductible policies linked to a health savings account. You can set up an HSA at a bank or brokerage firm. You contribute pre-tax or tax-deductible money to fund the HSA -- up to $3,300 for singles and $6,550 for a family in 2014, plus an extra $1,000 contribution if you’re 55 or older. Many employers also will contribute to your account.
You can contribute every year, and the money grows compounded tax-free. You can withdraw money tax-free at any time to pay for medical expenses, but why not let it grow? Once you’re on Medicare, you can’t contribute anymore, but you can keep the account. Consider this: If you and a spouse put away $7,550 a year starting at 55 in an HSA, you’ll have about $112,000 in tax-free savings for medical expenses when you enroll in Medicare at age 65 (assuming a 5% rate of return on your investments, before inflation).