Vanguard and Mercer Health and Benefits have developed a new framework that pre-retirees, retirees and their advisors can use to forecast health care expenses in retirement.
Unlike many other models, the framework focuses on annual costs, rather than costs over a lifetime, which can be daunting. It also separates long-term care costs from annual health care costs because long-term care costs are less predictable and many retirees will never incur them.
Here are the top tips from the framework discussed in Vanguard's new report, Planning for Health Care Costs in Retirement.
1. Frame costs in annual terms. The Employee Benefit Research Institute estimates that a typical 65-year-old couple will spend a total $265,000 in health care costs over their lifetime. The Boston College Center for Retirement Research estimated in 2010 a $197,000 outlay for a retiree couple. Neither estimate includes long-term care. These lump sums are overwhelming and potentially very inaccurate.
There are many variables involved in estimating health care costs in retirement and the total number can vary widely, according to the Vanguard report. A 65-year-old has a 50% chance of living another 24 years, and if she does, she could spend about $200,000 on health care. But if she dies by 81, she could spend less than $120,000, and if she lives to 95, she could spend more than $272,000.
"The range is wide and accounts for only 50% of the possible outcomes. This is why retirement planning professionals should focus on annual spending plans," according to the report. They should also consider, however, that costs will rise as seniors age due to inflation and the consumption of more health care services.
2. Personalize health care costs. Knowing a person's health history and current health status as well as the costs and coverage for Medicare plans, including Medicare Parts B (doctors and labs) and D (prescription drugs), Supplemental Medigap and/or Medicare Advantage Plans are important to understanding health care costs in retirement.
The Vanguard/Mercer Model considers 12 chronic health conditions, along with smoker status and number of annual doctor visits to establish a retiree's likely health care costs and divides people into three risk categories: low, medium and high.
It also considers geography, marital status, age at retirement and coverage choices, and models costs for women rather than men since their health care costs tend to be slightly higher over a lifetime — 2%.
The median annual health care cost for a 65-year-old woman is $5,200, according to the Vanguard/Mercer model, but it ranges from $3,000 to $26,000 based on risk, geography, type of coverage and income. (Taxpayers with adjusted gross income above $85,000 for individuals filing separately and couples above $170,000 filing jointly are subject to Medicare surcharges.)
Vanguard recommends also that pre-retirees understand their employer contributions to their health care coverage — it averages $5,300 per year for workers — because they will have to cover that cost in retirement.
