Most financial advisors are familiar with the problem that projected healthcare costs will pose to people in retirement—numbers that are, to say the least, alarming.
Fidelity Investments noted this year that an average retired 65-year-old couple in 2022 may need a mind-boggling savings of $315,000 (after tax) to cover their retirement healthcare expenses. Earlier this year, the Employee Benefit Research Institute noted that a 65-year-old couple with median prescription drug expenses needed $296,000 in savings for a 90% chance of having enough to cover their healthcare expenses in retirement.
But most financial planners aren’t telling clients to have that much money set aside. Instead, some are taking to heart recent research published by T. Rowe Price and Vanguard/Mercer Health & Benefits.
View Costs As An Annual Expense, Not A Lump Sum
Specifically, they are looking at healthcare costs as an annual expense instead of as a lump sum. That makes such expenses easier for retirees to plan and pay for, according to Sudipto Banerjee, a vice president at T. Rowe Price, who wrote one of several reports on the topic.
Financial advisor Massi De Santis uses Fidelity’s lump-sum estimate as a starting point to guestimate what a client’s annual healthcare expenses will be. “The $300,000 for a couple seems scary, but it is about $6,000 per year, per person,” says De Santis, the founder of DESMO Wealth Advisors in Austin, Texas. “Think of $150,000 divided by 25 years equals $6,000. I usually express the number to the clients as an annual average figure, instead of the sticker shock of $300,000.”
A joint report by Vanguard and Mercer Health & Benefits echoes that point of view: “We believe a better planning framework considers [healthcare] costs as annual expenses personalized to an individual’s health status, coverage choices, retirement age and loss of any employer subsidies,” says the report, titled “Planning For Health Care Costs In Retirement.”
De Santis, however, doesn’t rely solely on averages when incorporating healthcare expenses as part of a client’s financial plan. “It’s important to realize that the $6,000 is an average number,” he says. “Some years, especially the early years, this number can be much lower, and some years much higher if there is an unexpected surgery, etc. Some people that are healthier may end up paying less. Some may end up paying more, but there will be a cap due to out-of-pocket maximums. For this reason, I suggest starting with the average, which is conservative at the start, and review/revise the plan over time.”
In fact, as his clients get closer to retirement or if the clients are retired, he refines the $6,000 per person number using their state and health status, as well as a tool for financial advisors provided by Vanguard. “So we get a more personalized estimate,” he says.
Financial advisor Patrick Kuster, with Buckingham Strategic Wealth, agrees with that approach and says advisors “should consider planning for anticipated, annual healthcare expenses as part of a client’s annual income needs, while still customizing plans for large, unexpected out-of-pocket expenses that may come up through retirement. … As client health, age, life expectancy, location, preference and means vary, so should the numbers in their financial plans,” Kuster says.
Premiums From Monthly Income, Out-Of-Pocket Expenses From Savings
So how might financial advisors go about helping their clients plan for these costs? First, by breaking the costs down into those that are fixed and those that vary. According to Banerjee’s research, health insurance premiums are usually fixed and can be budgeted for and funded from monthly income. Out-of-pocket expenses can vary from month to month, however, and his research shows they could be paid from savings or a fund earmarked for those purposes.
Consider: For people age 65 and over who have traditional Medicare (Parts A and B) and a prescription drug plan (Part D), annual premiums are $2,500 for the 25th percentile and $3,300 for the 90th percentile. In comparison, out-of-pocket expenses for the 25th percentile are only $300 and they’re $5,000 for the 90th.
Not all advisors break out fixed and variable costs, however. “I don’t think it’s useful to just plan for the premium as fixed liabilities and the deductible and coinsurance as discretionary expenses, because they are not,” De Santis says. “What I think is useful with a client is to review how much will be fixed [the premiums] and how much may be variable [coinsurance and deductibles].