The True Price Of Retirees' Health Costs

(Dow Jones) Firm after firm spews out reports about how you'll need hundreds of thousands of dollars to cover health-care expenses in retirement. Are those costs real or is this--as some cynics suggest--a ploy on the part of investment firms to gather assets and generate revenue?

As with many things in life, the truth probably lies somewhere in between.

The latest report comes from Fidelity Investments which on Wednesday said the average 65-year-old couple retiring today will need $250,000 to pay for medical expenses in retirement. And that figure doesn't include potential nursing-homes costs, which average $80,000 per year in today's dollars.

Averages Can Be Deceiving
The "number," say skeptics such as Michael Zwecher, author of "Retirement Portfolios: Theory, Construction, and Management," is only an average and likely doesn't represent what health-care costs will be for the vast majority of Americans.

For Zwecher, the answer to paying health-care costs are two-fold: Either you save enough to self-fund the worst-case scenario, which according to one research firm could be as high as $807,000, or you buy long-term-care insurance.

Saving up for $250,000 in health costs is merely a 50/50 proposition, according to Zwecher. And if, by chance, you decide to set aside $250,000 to fund your health-care expenses in retirement, one of two things might happen based on your household's health profile, Zwecher says. Either you end up with a fund for discretionary expenses (cruises, Broadway shows, trips to Disney with the grandkids, and the like) for you and/or your survivors, or you have money to pay for a portion of your health-care expenses.

To be fair, others also present the need to fund health-care expenses in terms of the average net present value. Prudential Financial and the Center for Retirement Research at Boston College recently published a report noting that the "number," though less than what Fidelity reported, is still an average.

That research showed that the expected present value of lifetime uninsured health-care costs for a typical married couple age 65 is about $197,000 including insurance premiums, out-of-pocket costs, and home health costs. Add nursing-home care costs into the equation and the number hits $260,000. Net present value is, in layman's terms, the total value of a stream of outflows, adjusted by a discount or interest rate.

The Center for Retirement Research did note that there's a 5% chance that typical married couple age 65 would need $311,000, or $570,000 including the cost of long-term care, to pay for retiree health-care costs.

Others break down retiree health-care costs in different and perhaps more meaningful ways. The Employee Benefit Research Institute, in a 2009 report, provides men, women, and couples a way to get a handle on the financial consequences of longevity and investment risk, as well as the various types of medical-care coverage available when they reach age 65. In each case, EBRI estimates the amount individuals and couples need to cover retiree health costs 50%, 75%, and 90% of the time.

As with averages, though, probabilities might not help folks get a handle on how much they should set aside. It's hard for Medicare beneficiaries to determine whether they want to fund health-care expenses 25% or 90% of the time. (I think I'd like to fund those expenses 100% of the time).

Pay Out Of Pocket
At the moment, most retirees pay for health-care expenses in retirement out of pocket, according to Fidelity and others. They do so partly because they don't have money set aside in a bucket specifically earmarked for that expense and partly because they have the ability to pay out of pocket from their income, be it Social Security, earned income or investment income. Social Security benefits pretty much could be used to fund health-care expenses in the average retiree's household, by the way. Or at least that's the case in the first half of retirement.

Fidelity, which surveyed 376 married individuals, 65 years or older and not working full time, found the following: Health-care costs average $535 a month, or about 20% of an average couple's total monthly expenses of $2,842. Among those surveyed, 11% said their health-care costs are $1,000 a month or higher.

Average health-care costs, in Fidelity's survey, ranked second to the largest expense, food, which averaged $659 a month and slightly higher than housing-related costs, which averaged $494. What's more, almost half (47%) of those surveyed by Fidelity are paying more each month for insurance premiums and out-of-pocket health costs than they had anticipated for their retirement. And only three out of 10 of these retirees saved specifically for health-care needs in retirement during their working years.

Another survey found that retirees spent less on health care, though it was still out of pocket. The average 65-year-old-and-older household spent $4,631 per year on health care in 2007 according to a U.S. Labor Department's Consumer Expenditures report. That represented about 13% of the average Medicare-eligible household's $36,530 in expenses according to the Labor Department. As with other studies, the rising cost of health care for retirees is driven largely by increases in Medicare Part B and Part D premiums.

Pay Later
What's the takeaway here? In short, experts suggest that if you do plan to pay for health-care expenses as you go, consider that it could represent upwards of 20% of your expenses, and health-care costs are likely to rise faster than other expenses such as food or housing.

In fact, by the end of life, health-care expenses, after factoring an inflation rate of 7%, could exceed a whopping $30,000 per year, according to Ron Mastrogiovanni, president of HealthView Services Inc.

Of note, health-care cost estimates have risen 56% since Fidelity introduced its report in 2002. For its part, Fidelity said "the significant jump in the retiree health-care cost estimate from 2002 to 2010 can be attributed to a number of factors including higher costs (e.g., for doctor's visits, diagnostic tests); increased expenses associated with new technology; and general price inflation."

In addition, Fidelity noted that its survey assumes individuals do not have employer-provided retiree health-care coverage, but do qualify for Medicare. The Fidelity estimate takes into account cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B. It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services and long-term care.

Save Now
If you decide to start saving and earmarking money for retiree health-care expenses, consider the following: Everything you save now might ultimately be used to pay just for health care, not food, transportation or housing. Consider the case of an average 40-year-old who might be saving $4,000 per year and who plans to retire at age 67. Using back-of-the-napkin calculations, that $4,000 saved would ultimately grow, assuming reasonable rates of return, to a size sufficient to cover 20 years of insurance premiums, co-pays, deductibles and the like in retirement.

Either way it's a gamble.

To borrow a phrase from that famous commercial about mufflers, you can save for health-care expenses now or pay later. If you choose the former, the investment firms might benefit. If you choose the latter, they don't. But no matter what you choose, you'll be paying regardless.