Health care costs force many clients to rethink retiring early.

For many clients, and even advisors, the ability to plan ahead for an early retirement is often predicated on disciplined saving and wise investments.

Over the past few years, however, clients and their advisors are finding another factor increasingly springing up as a key-and sometimes determining-factor in early retirement planning: health care costs.

The dramatic rise in health care costs in recent years has gotten to the point where this one line item in a client's retirement plan can make or break a goal of retiring before the Medicare-eligible age of 65, advisors say.

"It's been an issue the past four to five years that has, at least in my humble opinion, been coming to a head the last year or two," says Dick Hammel, of Hammel Financial Advisory Group in Nashville, Tenn. "It's something that really needs to be faced and publicized well to the average consumer."

Part of the problem, advisors say, is that clients who have spent their whole careers living under an employer-sponsored medical plan will start setting retirement goals without being aware of how much income individual health insurance premiums can consume. By the time they're ready to sit down with an advisor and put their plan to print, they get blindsided by the health care issue. Yet even those clients who are aware of the issue aren't in a much better situation, simply because there's little they can do to offset the costs. Some advisors relate cases in which insurance premiums suddenly obliterate 30% or more of a client's income, sometimes dashing all hope of retiring anytime before the age of 65.

"I can tell you that I've had in the last year a good four to six clients who had health care costs as one of the primary issues as to whether they thought they should retire or not," says Mark Berg, a fee-only advisor with Timothy Financial Counsel in Wheaton, Ill. Few clients realize the hit their retirement plans take going from an employee-sponsored plan, where workers pay about 30% of the cost, to a self-funded individual plan, he says. "Everyone is surprised."

It is a frustrating issue, says planner Chris Cooper, because it affords clients and their advisors so few options-even if clients are perfectly healthy. When it comes to bridging the gap between an early retirement and Medicare eligibility, clients' have the opportunity to purchase COBRA benefits during the first 18 months of their retirement. After that, clients are basically on their own in finding individual plans. In some situations, such as when a spouse suffers an illness that essentially makes them uncoverable, these costs can make an early retirement impossible. There are some changes down the road that could help. One tool on the horizon, health savings accounts (HSAs), allows clients to set up pre-tax savings accounts to help fund low-premium, high-deductible medical insurance. But few HSAs are currently available, and advisors seem divided on how much impact they will have.

"I've seen quite a few clients abandon their retirement plans because of this issue alone," says Cooper, who owns Chris Cooper & Co., an advisory firm in Toledo, Ohio. "Once they see the price, they just don't want to do it."

And the prices keep on soaring. Increases in health care costs, according to government statistics, have outpaced inflation for six years in a row. Many experts predict it will happen again in 2004. Furthermore, the gap between the Consumer Price Index and health-benefit costs has been stark. While annual increases in the CPI have been under 5%, increases in health care costs have been 10% or more in recent years. Medical costs, in fact, have outpaced the CPI for 13 out of the past 17 years, according to the U.S. Bureau of Labor Statistics.

Each passing year of increases has, for some clients, amounted to another brick in a wall separating them from plans to retire before the age of 65. That's because advisors say there's no way around them. Unlike investments, upon which advisors can apply some creative thinking, health care costs represent an unmovable obstacle. Unlike living expenses, they can't be adjusted down without major consequences. And, advisors note, you can't shop around for better prices without facing a monumental risk if a serious illness or injury happens. Short of the availability of HSAs, there's little clients and advisors can do except deal with the costs and work around them.

That's where clients can run into trouble. Cooper says that in most of the cases he's seen, clients are seeing their monthly health insurance premiums jump from five to ten times if they leave an employee-sponsored plan and get an individual plan. A worker might pay $150 per month from his or her paycheck to a company plan, but could face monthly payments of $1,000 to $2,000 in an individual plan. Sometimes the costs can be worked down, Cooper says, but the client is left with a stripped-down plan that might not provide coverage for prescription drugs and outpatient procedures or might require a high deductible.

Cooper has one client, a 61-year-old forklift operator, who has come to his office with his wife repeatedly over the past two years trying to figure out a way to retire. His lone obstacle: health care costs.

"He keeps trying to think up schemes to get around health insurance," Cooper says. "Things like, 'We just won't go to the doctor,' or 'We'll go to free clinics,' or 'We'll go to the emergency room and declare ourselves indigent.' None of that works, of course, because they pick up your Social Security number and [put a] lien on the house and bank accounts."

Limited groups of clients-those who are retiring from businesses they own-are finding a way to wend their way around the problem, says Neil Brown, a fee-only advisor and owner of Advanced Financial Planning in Columbia, S.C. Many of these clients, he says, are retiring early while maintaining limited employment status with their companies to retain health benefits.

"They will do some consulting work or whatever else is required to stay on the payroll," Brown says.

For any client with less than $1 million in assets and who wants to retire before age 65, the cost of health care "really is a hindrance, just from the standpoint that you can only spend so much money without taking substantial risk of depleting your assets early," Brown says.

Hammel tells of a married couple, a husband who will turn 65 at the end of this year and a wife who is a year younger, who decided to absorb the increased cost of health care when they retired seven years ago. What they didn't envision, however, was the drastic increase in health care costs they've had to absorb since. Since their retirement, the increases in their premiums have been as high as 50%, Hammel says. The couple is currently paying about $1,100 per month for health care insurance, which Hammel says represents nearly one-third of their entire income. "It's like having an extra house payment," Hammel notes.

The payment is having a cancerous effect on their overall retirement plan. The couple was forced to start accepting Social Security payments early, when they each turned 62. Also, they are drawing off their $500,000 in assets at the rate of 8% to 9% annually, much higher than the 4% to 5% normally favored by advisors. Their situation may grow more difficult. While the husband is set to start receiving Medicare at the end of the year, his wife had another year to go before eligibility. But she suffers from diabetes and other health problems and it's expected that any individual policy they find to cover her for a year will be more expensive than the one they have now, says Melissa Hammel, Richard Hammel's daughter and partner.

The couple has already cut back on their travel plans and is selling a boat and a motor home to deal with the added costs, Melissa Hammel says.

"Her having her own policy is going to be unbelievably expensive," she says.

Even younger clients are sometimes stunned by the impact health care costs can have on their retirement planning. Berg has a client who is about 35 years old, and making $250,000 a year, who came into his office feeling he was all set to retire at 55. Then Berg started plugging in numbers. He projected an 8% to 10% annualized return on assets and a general inflation rate and annualized increase in salary of about 3% to 4% each. Then came the monkey wrench that the client hadn't considered: a projected 14% increase in health care costs.

When everything was totaled up, including his expense projections, Berg found that the client and his wife would run out of money when he hit the age of 85. That's a perilous situation in the minds of many advisors, who like clients to have enough money to fund retirement until the age of 95 or 100.

The client was stunned by the analysis. One reason he hadn't factored in health care costs, Berg says, is that his company-sponsored plan is generous and includes very little out-of-pocket expenses for employees.

That's why, Berg says, many employees these days value good medical plans more than perks such as signing bonuses. He notes that when Caterpillar, a large local employer, downgraded their retiree employee insurance plans last year, it sparked a rash of early retirements. "People retired early just to get the rich medical coverage," he says.

Advisors interviewed had differing views on the value HSAs will have as they become more available to the general public. One advantage advisors noted is that HSAs, unlike medical savings accounts, are not "use it or lose it" from year to year. In that sense, HSAs can act as a viable pre-tax savings vehicle that can provide significant reductions in annual health insurance premiums. This, however, is offset by the fact that clients will be facing high deductibles in the event that medical needs arise.

That's why some advisors feel that HSAs will be most utilized by younger, healthier individuals who will focus on HSAs as a savings vehicle. They note that money can be withdrawn from an HSA for non-medical purposes, and without penalty, after an individual attains Medicare eligibility. Cooper, who believes HSAs won't provide a good tradeoff for the average client, feels the people who will get the most from HSAs are doctors, who usually get their medical treatment free as a "professional courtesy."

"If you're a doctor and maxed out at $40,000 a year on a pension plan, this is a great opportunity," Cooper says. "Those are the only people it works for."