How to plan for medical expenses in retirement

Medicare pays for many of the health-care costs incurred by older Americans, but it doesn’t cover everything. This creates a financial-planning problem — how much should a person expect to pay in out-of-pocket healthrelated expenses during retirement?

It’s a tough question because there are so many unknowable factors: What medical problems will you face? How much will Medicare insurance programs pay? How long will you live? What about long-term care?

The bad news is that several recent studies warn that Americans on average should plan on spending well over $100,000 just in out-of-pocket medical costs during retirement.

But the good news, or at least better news, is that the challenge isn’t so overwhelming if you break down the projected expenses into a smaller annual figure.

In a report released in June, the Vanguard Group, with help from Mercer Health & Benefits, projected a typical woman could easily face $200,000 in out-of-pocket medical costs starting at age 65 and extending over her remaining

estimated lifespan of 24 years. (The costs are roughly 2 percent less for men, partly because they tend not to live as long.)

That projection doesn’t include food, housing and other routine expenses — just medical outlays.

But the report instead encouraged people to focus on these costs as an annual expense, not as a lump sum.

It estimated that the same hypothetical woman would spend about $5,200 in annual health expenses in the first year, at age 65, rising gradually after that with inflation. That’s a more reasonable number — a lower figure that might encourage more people to view the challenge as achievable.

That annual figure encompasses most medical expenses retirees would face, including Medicare insurance premiums, drug costs and other out-of-pocket outlays. But it doesn’t include long-term care, which could run tens of thousands of dollars for some retirees or nothing at all for others.

At any rate, $5,200 or so sounds a lot better than a couple hundred thousand dollars.

Multiyear lump-sum projections are fairly unusual anyway, as people tend to think more in annual costs when making decisions.

In a similar vein, the Vanguard/Mercer report explained that single-person households in retirement spend about $16,900 a year on average for food, clothing and shelter (excluding medical expenses), citing numbers from the Bureau of Labor Statistics.

Yet that same $16,900 estimate, projected over a 24-year retirement stretch and without factoring in inflation, would jump to more than $400,000.

Larger lump-sum numbers could become “behaviorally distracting,” the report stated, meaning people could become so discouraged about saving that much money that they throw in the towel before trying.

Nevertheless, lump sums are the way many studies estimate out-of-pocket costs for retirees.

For example, the Center for Retirement Research at Boston College recently estimated a typical 65-year-old couple would need roughly $197,000 for healthcare spending in retirement.

The Employee Benefit Research Institute assumed a 65-year-old couple would need $265,000, while a Fidelity Investments study projected that a couple starting at age 65 would need around $280,000. None of those estimates included potential costs for long-term care.

The point of the Vanguard/Mercer approach wasn’t to minimize the amount of money retireesmight need for medical expenses. Rather, it was to portray the challenge in smaller, more manageable, annual chunks.

Most studies “point to a daunting outof-pocket healthcare expense over the lifetime of a retiree,” said Jean Young, one of the authors of the study and a senior research associate at Vanguard. “These large dollar values can be demotivating.”

It’s important to recognize that the various cost estimates are broad. While the Vanguard/Mercer report projected a baseline $5,200 annual cost for a 65year-old woman, likely yearly expenses could vary from as little as $3,000 to more than $26,000.

Personal health and other factors can push the numbers higher or lower. So can factors like changing prices for prescription drugs.

It’s also worth remembering thatfor people who retire early, big medical outlays could begin prior to age 65, when Medicare eligibility begins. Some early retirees could have access to subsidized medical insurance through work that covers most health costs.

Alternatively, nonworking individuals can obtain private insurance on their own. Regardless, people who retire before 65 “need to have a strategy to bridge their health-care coverage between retirement and Medicare,” according to the study.

Then there’s long-term care. Planning for these expenses are particularly difficult because, while about half of seniors will require paid care, others might not need to spend much, if anything.

The Vanguard/Mercer report recommends that people consider a range of resources to pay for long-term care, including personal savings and the equity in their homes.

Long-term-care insurance, while expensive and difficult to qualify for, might be another option. So, too, for certain annuities that feature larger payments for people who need care.

Medicaid, not Medicare, is the government program that pays for long-term care as a last resort, after people have depleted most of their other assets or didn’t have much to begin with.

The Vanguard/Mercer study included several other tips for people seeking to grapple with out-of-pocket medical costs in retirement. These include the following:

❚ Consider Medicare choices carefully, as the type of coverage you choose matters a lot. Retirees may enroll just in original Medicare or pay extra for additional coverage. The report recommended Medicare Advantage, a popular private-insurance addition, as a cost-effective option.

❚ Start using health savings accounts if you’re still working. These accounts, which require enrollment in high-deductible health insurance plans, allow people currently employed to accumulate money to meet medical costs in retirement. In other words, workers can pay current medical expenses from regular income while letting money in the accounts grow. Contributions are tax-deductible, the money builds tax-deferred and withdrawals come out tax-free if used for medical expenses.

❚ Stay healthy, if you can. Exercising, eating well, taking required medications as prescribed and following other smart behaviors also can reduce out-of-pocket health costs. Even factors like marital status and employment can make a difference — married people who keep working into retirement age tend to report better health, the study said.