Health Insurance in Retirement

October 26, 2012

Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

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, even a relatively minor hospital stay could derail your finances. A major illness could be financially devastating. 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 the age of 65, compare the cost of continuing your medical and dental coverage with your former employer (for up to 18 months through the federal COBRA program) with the cost of insurance you might be able to obtain on your own. All other things being equal, group coverage tends to be cheaper than individual coverage. But all other things are seldom equal, and electing COBRA coverage may not always be the best decision.

If you get an individual policy, you might be able to tailor a lower-cost solution that’s better suited to your unique circumstances. For example, your employer plan premiums might be higher because maternity coverage is included – something you may not need if you're beyond childbearing years. On the other hand, if you already have a chronic illness that might cause you to spend more on an individual policy, you might 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, an additional 18 months.

You might feel some sticker shock when you look at individual or COBRA costs – but remember that you were probably already paying a significant portion of your health insurance premiums at work through payroll deductions. For example, if your employer was deducting $135 every two weeks, you were already paying $3,500 a year for coverage. If that's the case, you'd only need to budget an extra $4,000 if you bought a new policy costing $7,500 a year.

Reality check: post-retirement health care costs

We should acknowledge up front that 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 key unknowables: how much health care you'll need, how long you'll need it, and the inflation-adjusted return on your money.

But let's do a quick back-of-the-envelope calculation based on a few key assumptions. Because of fast-growing costs, we'll assume a health care inflation rate roughly triple the projected Consumer Price Index.

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. If you assumed 25 years, you'd need about $358,000.¹

Remember, these calculations are a hypothetical example and don't account for the reality that investment returns fluctuate. Using a sophisticated Monte Carlo simulation 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. (A Monte Carlo analysis runs thousands of portfolio simulations that take volatility into account and then compute the probability of success for a range of outcomes.)

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 it on

There's a common misconception that, once you're eligible for Medicare, you'll have all your health care costs covered for the rest of your life. Not so.

Medicare Part A covers inpatient hospital stays, care in a skilled nursing facility, hospice care, and some home health care. You usually don't pay a monthly premium for Medicare Part A coverage if you or your spouse paid Medicare taxes while working.

Medicare Part B is medical insurance, and covers "medically necessary" services such as lab tests and surgeries, medical supplies such as walkers and wheelchairs, and preventive care. There's a monthly premium for Part B, which varies depending on your income.

Medicare Parts C and D cover prescription drugs, and cost extra.

Be aware that, 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:

So, if you're like a lot of people, you're looking at the possibility of a long retirement with a lot of health care expenses that won't be covered by Medicare. How can you bridge the gap?

Purchase long-term care insurance

According to the National Association of Insurance Commissioners, most people over 65 (about 59%) don't spend any time in a nursing home. But for those who do, the costs can be staggering. The American Council of Life Insurers projects that, by 2030, a 2.6-year stay in a nursing home (which is about the average for those who do enter a nursing home) will cost about $520,000.² And it isn't covered by Medicare; it's covered by Medicaid—which, as a general rule, is only available to people who meet certain requirements such as prior military service or low income.

Though you may never need it, if you're near or in retirement you might consider long-term care insurance, which covers medical and nonmedical care for those with a chronic illness or disability. This insurance may be particularly attractive if you have insufficient assets to self-insure but a net worth too high to receive Medicaid.

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. The National Association of Insurance Commissioners produces A Shopper's Guide to Long-Term Care Insurance, which is worth a look. 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.

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. For information on selecting an appropriate policy, see Choosing a Medigap Policy: A Guide to Health Insurance for People With Medicare.

1. The formula is for the present value of a growing annuity:

2. http://www.acli.com/Consumers/Long-Term%20Care%20Insurance/Pages/Default.aspx