Retirement and Health Insurance—What You Need to Know
October 23, 2013
- Set realistic expectations for what you'll need to spend on health care in retirement, and plan now for future expenses.
- Even modest yearly health care costs can take a big bite out of your retirement nest egg.
- Medicare is only part of the health insurance equation in retirement: For many expenses, including long-term care, you'll need to foot the bill yourself or look elsewhere for insurance coverage.
After years of planning and saving for retirement, the last thing you want is for medical bills to undo your hard work. But without adequate health insurance in retirement, even a relatively minor hospital stay could derail your finances. Let's take a look at what you can do to help mitigate the possible impact of health problems on your finances.
Retiring early? Stay insured
If you're under age 65, compare the cost of obtaining insurance on your own with the cost of continuing medical and dental coverage through your former employer. (Former employees are entitled to up to 18 months of coverage under the Consolidated Omnibus Budget Reconciliation Act, or COBRA.) All else being equal, group coverage tends to be cheaper than individual coverage.
If you get an individual policy, you might be able to find a lower-cost solution that's better suited to your unique circumstances. For example, your employer's plan premiums might be higher because it includes maternity coverage—something you may not need if you're beyond childbearing years. On the other hand, if a chronic illness might cause you to spend more on an individual policy, you might be better off with the COBRA option.
In addition, most states have programs that will allow you to extend COBRA coverage. For example, eligible California residents have the option to extend COBRA coverage, beyond the federal allowance.
You might feel some sticker shock when you look at individual or COBRA policy costs, but remember that you were probably paying a significant portion of your health insurance premiums at work through payroll deductions. For example, if your employer was deducting $200 every two weeks, you were already paying $5,200 a year for coverage. If that's the case, you'd need to budget an extra $4,800 if you bought a new policy costing you $10,000 a year.
Reality check: post-retirement health care costs
It's hard to predict exactly how much money you'll need to cover health care costs in retirement because the cost depends on several unknowns: how much health care you'll need, how long you'll need it for and the inflation-adjusted return on your money.
If you're under age 65 and not yet eligible for Medicare (see below), how much you will pay for insurance depends on a number of factors. Keep in mind that under the new federal Patient Protection and Affordable Care Act (ACA), individual states are setting up private health insurance exchanges. How these exchanges will impact the cost of insurance will likely depend on participation rates, age, smoking status, and income levels. Some individuals may pay more, and some may pay less.
That said, let's do a quick back-of-the-envelope calculation based on a few key assumptions. Because of growing costs, we'll assume a health care inflation rate roughly triple the projected Consumer Price Index.
- First-year costs = $10,000
- Health care inflation rate = 8%
- Rate of return on lump sum = 5%
- Time horizon = 30 years
You'd need a lump sum of about $465,000 at the start of your retirement to cover your inflation-adjusted costs for 30 years.1 If you assumed 25 years, you'd need about $358,000.
Remember, these calculations are a hypothetical example and don't account for fluctuating investment returns. Using a sophisticated Monte Carlo simulation,2 assuming a moderately conservative portfolio return of 4.2% per year, we estimate you'd need about $570,000 to achieve a 90% chance of being able to pay retirement health costs of $10,000 in the first year, rising 8% a year for 30 years.
The goal here is not to frighten or discourage you, but simply to point out that a significant portion of your retirement savings may go to health care costs.
What you'll spend health care savings on
There's a common misconception that once you're eligible for Medicare, all your health care costs will be covered for the rest of your life. However, Medicare does not cover everything. Medicare Part A covers inpatient hospital stays, care in a skilled nursing facility, hospice care, and some home health care, while Medicare Part B covers "medically necessary" services such as lab tests, surgeries, medical supplies and preventive care. Medicare Parts C and D cover prescription drugs and are an additional expense.
Even if Medicare covers a particular service or item, it still works like any other type of insurance: You'll generally still have deductibles and copayments. Additionally, there's a whole range of services that Medicare doesn't cover.
|What Medicare doesn't cover|
|Type of service||What you'll pay for:|
|Acupuncture||Any type of acupuncture|
|Cosmetic surgery||Cosmetic surgery, unless it’s needed because of accidental injury or to improve the function of a malformed part of the body|
|Dental services||Most routine dental care and procedures such as cleanings, fillings, tooth extractions, dentures, dental plates or other dental devices|
|Eye exams||Routine eye exams (refractions) for eyeglasses or contacts|
|Eyeglasses/contact lenses||Eyeglasses or contact lenses except for intraocular lenses following cataract surgery|
|Nursing home care||Custodial care, like help with bathing or dressing, when it’s the only kind of care you need|
|Physicals||Routine annual physicals, except the one-time "Welcome to Medicare" physical exam|
|Medical supplies used at home||Common medical supplies like bandages and gauze|
|Transportation (routine)||Transportation to get routine health care|
|Health care outside the U.S.||Most health care while you are traveling outside the U.S.|
Bridging the gap between expenses not covered by Medicare
If you are like a lot of people, you're looking at the possibility of a long retirement with health care expenses that won't be covered by Medicare. You can purchase two additional insurances to help cover extra medical expenses:
- Supplemental insurance: Medigap policies are sold by private insurers and act as supplemental insurance to Medicare. Coverage options and prices vary by program and state. Your total premiums (Medicare and Medigap) will likely be less than what you were paying prior to age 65.
- Long-term care insurance: Though you may never need it, if you have insufficient assets to self-insure but a net worth too high to receive Medicaid, which is usually only available to people who meet certain requirements, such as prior military service or low income, you might want to consider long-term care insurance. Long-term care insurance covers medical and nonmedical care, like nursing homes, an expense covered by Medicaid, not Medicare. The American Council of Life Insurers projects that, by 2030, a 2.6-year stay in a nursing home (the average nursing home stay) will cost about $520,000.3
If you do opt for this additional coverage, note that premiums can vary widely, depending on age and coverage, and tend to be most cost-effective for those between 50 and 65 who are in good health. Read the fine print to determine what's covered—skilled nursing, custodial care, assisted living, etc. What medical conditions qualify for benefits? How long before they kick in? How long will they last? What's the maximum daily benefit? Is there inflation coverage? How solid is the insurer? And what's its history with regard to long-term health care policies? Look for a policy that is guaranteed renewable with locked-in premium rates.
Finally, we recommend you seek out objective sources of information, such as your state insurance commission. As with all your health care choices, it's also wise to check with your insurance broker, professional associations or affinity groups like the American Association of Retired Persons to compare costs and benefits.
Talk to us about your retirement. Call 877-673-7970 to schedule your Personal Retirement Consultation or visit a branch near you.
1. The formula is for the present value of a growing annuity, a series of annual payments:
2. Monte Carlo analysis runs thousands of portfolio simulations that take volatility into account and then computes the probability of success for a range of outcomes.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized retirement advice. The strategies mentioned here may not be suitable for everyone. Each investor needs to review a strategy for his or her own particular situation before making any decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.