Long absent from the income/longevity equation, it now bears heavily upon the mathematics of retirement
by Ron MastrogiovanniMr. Mastrogiovanni is CEO of HealthView Services and HealthyCapital. HealthView Services (www.hvsfinancial.com) is the leading provider of retirement healthcare cost data, Social Security optimization, and long-term care retirement planning tools for the financial services industry. HealthyCapital (www.healthycapital.com) provides tools and savings data from condition management to incentivize improved health and retirement healthcare savings.
When it comes to retirement, most advisors use potential longevity as a guide to frame planning goals with clients. Using an estimated lifespan, they project housing costs, transportation needs, vacations, and a range of other retirement expenses into the future.
Healthcare costs – which are also directly related to longevity – have not, until relatively recently, been an area of focus.
Healthcare costs are a predictable expense that can be planned for, provided that clients pay for Medicare and supplemental insurance. Health-related events such as a heart attack or a diabetes diagnosis will not impact the cost of premiums.
The combination of Medicare Parts A, B, and D coverage will ensure expenses related to hospital visits, basic outpatient healthcare, and prescriptions are addressed. But these plans still require copays and leave open the potential risk of significant uncovered costs. By purchasing supplemental insurance Plan G (Plan F is being eliminated for new subscribers at the end of 2019), which covers copays and other out-of-pocket costs not included under basic Medicare, retirees will have comprehensive healthcare coverage and minimal variability in annual expenses.
Planning For Health
To ensure predictable healthcare costs, retirees need to plan to cover both Medicare premiums and supplemental insurance through retirement. These premiums are the most significant component of overall healthcare expenses in retirement and will gradually increase over time, driven by healthcare inflation. Financial planning to address them, as well as healthcare expenses that aren’t covered by Medicare, such as dental, hearing, and vision, is essential.
Drawing on 530 million healthcare claims, actuarial and government data, we are able to project at an individual level future healthcare expenses based on current age, gender, income, health condition, and location.
In our white paper, Why Health Needs to Be Part of Retirement Planning, we show that a healthy 65-year-old couple retiring this year will, assuming average life expectancy, need to plan for total lifetime retirement healthcare expenses of $572,960, in future dollars. This is for Medicare Parts B and D, supplemental Plan G, dental insurance and projected out-of-pocket costs for hospitalization, doctors, tests, prescription, dental, vision, and hearing.
In the first year of retirement, their projected average annual expenses will be $12,286. Driven by healthcare inflation, by the time they reach age 85, the annual price tag will rise to $34,268 (future value).
Total Projected Annual Healthcare Costs for an Average Healthy 65-Year-Old Couple Retiring This Year (Future Value)
The compounding impact of annual healthcare cost increases close to 4.5% will mean that today’s 40 and 50-year-old couples will face a far higher burden of healthcare expenses when they retire.
Let’s frame this in another way. If a client has saved $1 million with the goal of generating $45,000 a year in retirement income, their annual healthcare expenses will significantly reduce what they have to spend for other priorities. For an individual with an estimated $300,000 in healthcare costs, that would leave an average of only $31,500 per year (before taxes) to spend on non-health-related expenses.
Longevity: The Key Variable
Although annual healthcare premiums are predictable, longevity is a key variable that must be factored into the retirement planning process. Recognizing that longevity at an individual level will vary, actuarial projections based on client health provide the strongest basis for planning decisions.
Since chronic conditions such as diabetes will affect longevity, they need to be incorporated into an advisor’s planning process to address future healthcare premiums and out-of-pocket expenses.
For example, the expected longevity of a 55-year-old woman with Type 2 Diabetes is age 80. Her projected total lifetime healthcare costs for planning purposes would be $266,163, significantly lower than a comparable healthy woman who is expected to live to age 89. The healthy woman would realistically need to plan for $424,875 in health outlays – the result of nine more years of healthcare costs in retirement.
Lifetime Healthcare Cost Comparison, 55-Year-Old Woman (Today’s Dollars)
There are several important points to note here. The first is if the woman with diabetes were to take steps to better manage her condition (and this applies to many chronic conditions), she will increase both her projected actuarial longevity and lifetime healthcare expenses.
A second point is that a medical event or diagnosis may impact longevity. For example, the diagnosis of diabetes (like in the example above) needs to be incorporated into retirement planning because it will likely change the savings required to cover all expenses, including healthcare, over the foreseeable remainder of life.
When Long Term Care Is Needed
Health events or diagnoses may also increase the likelihood that long-term care will be required. With the national average annual nursing home costs currently exceeding $75,000, for example, having a plan to address potential long-term care expenses is essential in order to avoid costly expenses at end-of-life.
We need to recognize that the most significant financial risk from health events in retirement is not incorporating healthcare into the financial planning process. For advisors, this is an opportunity to leverage their expertise to help clients plan for these expenses and increase AUM.
Discussing common misconceptions about healthcare in retirement is a starting point for planning conversations. Most clients simply do not understand how Medicare works or the magnitude of future health expenses. In some cases, they don’t even understand that they’ll need to pay premiums in retirement.
Social Security Insufficient
Additionally, many have the misconception that Social Security will be sufficient to live on and address healthcare expenses. Since cost-of-living adjustments (COLAs) for Social Security are projected to run far below healthcare inflation, few clients understand that premiums will take an ever-larger chunk out of Social Security payments, with Part B premiums and Medicare surcharges for Parts B and D directly deducted from benefits checks.
Clients on track to achieve a recommended income replacement ratio (IRR) goal of 80% may also be shocked to find that they will fall short of what they need to save to ensure healthcare costs are covered. Why? Because while working, employers often pay approximately 75% of total healthcare premiums for employees. In retirement, individuals have to pay 100% of their healthcare premiums. In the first year of retirement, annual healthcare premiums will be almost double for a 65-year-old couple compared to what they paid for a national average HMO at age 64, when they were still working. This isn’t factored into IRR-based savings.
Average Healthcare Premium Cost Comparison of 64-Year-Old Couple to 65-Year-Old Couple
Our experience in working with many of the largest financial services organizations and leading independent advisors is, when healthcare is incorporated into planning discussions, clients increase retirement savings. Clients’ contributions to investment accounts, and specifically 401(k)s, have grown in large pools of employees by as much as 25%. This underscores the value clients place on ensuring that their healthcare needs will be covered in retirement.
When advisors build into client conversations the importance of saving to fund future healthcare coverage, and the need to protect themselves from the financial risk of catastrophic health events or skilled nursing care needs, the case for action becomes stronger still.
There’s another powerful reason for advisors to discuss healthcare planning with clients – Medicare Surcharges. Most affluent clients will at some point be subject to these surcharges (which range from 33% to 201% of basic Medicare premiums) when Modified Adjusted Gross Income (MAGI) exceeds Income-Related Monthly Adjustment Amount (IRMAA) brackets.
It is important to note that certain financial products (including life insurance, certain annuities, health savings accounts or HSAs, and Roth IRAs,) don’t count toward MAGI. Knowing this, advisors can help clients potentially reduce surcharges by optimizing annual income distributions from available sources with healthcare in mind. Since surcharges may be triggered by events such as capital gains from the sale of a home (which will increase MAGI), advisors can also help clients better plan around these events to avoid surprises.
Although for the first time in a decade, surcharge brackets will be indexed to the CPI-U inflation metric starting in 2020, retirees can expect to be subject to higher surcharges during the course of retirement as their overall inflation-adjusted income rises, commonly as a result of events such as the inclusion of required minimum distributions (RMDs). This needs to be factored into retirement plans.
In summary, since health-related events or diagnoses will impact longevity and projected lifetime costs, the planning process needs to be dynamic. Improved health may also increase potential longevity and counter-intuitively lead to higher lifetime costs.
Annual retirement healthcare expenses are predictable, assuming clients plan to cover the necessary Medicare and supplemental insurance premiums. Although lifetime expenses will vary, leveraging actuarial longevity data based on health condition, a health event, or diagnosis provides a planning framework for understanding future expenses and savings decisions at an individual level.
The ability to cover healthcare needs is at the top of most clients’ lists of retirement planning priorities. The path to ensuring health events do not have a catastrophic impact on a client’s retirement finances starts with a detailed discussion of how they can take this risk off the table by planning to fund to the healthcare coverage they will need. In the process, advisors have an opportunity to add value, increase assets under management, and create new opportunities to discuss product choices. ◊