The widespread use of the income replacement ratio (IRR) as the basis for determining how much savings will be needed in retirement has a glaring drawback that may lead many individuals to accumulate less than what they may need for health care costs in retirement.

Since many Americans pay only a fraction of their health care costs during their working years, a simple IRR approach may not adequately account for the burden of bearing a larger share of those costs in retirement.  The IRR also ignores the potential that health care expenses will likely represent a greater portion of a senior’s budget than during his or her working years.

Another shortcoming of IRR is using a Consumer Price Index inflation assumption to project income needs to maintain purchasing power. Health care inflation has historically exceeded the general inflation rate by substantial margins, and is expected to do so for many years to come. A general inflation rate may underestimate the income needed to meet health care costs. For instance, an individual retiring this year could pay $33,000 more in total health care costs in retirement than someone who retired just one year ago.¹

An Overview of Future Health Care Costs

For a 65-year-old couple retiring today, health care costs—including Medicare, supplemental insurance premiums and out-of-pocket expenses—will amount to $377,412 in present value dollars and $567,903 in future value dollars.²

For the 55-year-old couple, the present value cost rises to $465,907 and balloons to nearly $1 million in future value costs over the anticipated life of retirement.³

If individuals think that Medicare will solve this health care challenge, they may need to think again. In 2012, Medicare covered just 60 percent of the cost of health care services for individuals 65 and older, while out-of-pocket spending accounted for 13 percent and private insurance covered 15 percent.⁴

Long-Term Care Not Included

The projections for health care costs cited above, sadly, do not include the cost of long-term care.  According to the U.S. Department of Health and Human Services, long-term care will be needed by 7 in 10 individuals at some point over age 65.⁵   And, it won’t come cheap.  According to a recent survey of long-term care costs, home care costs averaged $3,520 per month; assisted living arrangements, on average, cost $3,600 per month; and nursing homes cost an average of $7,000 per month.⁶

Advisors need to educate their clients to this looming challenge and communicate strategies to meet it, such as saving more, contributing to Health Savings Accounts and purchasing long-term care insurance.

Sources:

1. “2016 Retirement Health Care Costs Data Report,” HealthView Services.
2. “2016 Retirement Health Care Costs Data Report,” HealthView Services.
3. “2016 Retirement Health Care Costs Data Report,” HealthView Services.
4. EBRI Notes, “Amount of Savings Needed for Health Expenses for People Eligible for Medicare,” Employee Benefit Research Institute, October 2015.
5. http://longtermcare.gov/the-basics/who-needs-care/
6. Genworth Cost of Care Survey: 2015.

See referenced disclosure (2) at https://blog-dev.americanportfolios.com/disclosures/