Fidelity Investment’s 2022 Retiree Health Care Cost Estimate increased 5% from 2021, and the figure has nearly doubled since the initial $160,000 estimate in 2002.
For 2021, Fidelity’s health care cost estimate was $300,000. Hope Manion, chief health and welfare actuary at Fidelity Investments Benefits Consulting, says that health care costs are likely to continue rising.
“[T]he costs will continue to go up because of the nature of health-care consumption, where we have so much innovation and technology and improvements in care,” she explains. “We need to be bold and stand up to the reality and get prepared for it.”
For 2022, Fidelity estimates that a 65-year-old couple retiring this year can expect to spend an average of $315,000 on health care costs throughout retirement. The estimates for single retirees are $150,000 for men and $165,000 for women. For single retirees, the 2021 estimate was $157,000 for women and $143,000 for men.
“We did have a little bit of a leveling off, a bit of a break, in the last few years,” Manion adds. “What we’re seeing right now is a return to a as an acknowledgment that that trend is back in health care—there’s a lot of cost [and] inflation pressure that’s going to be happening short-term, [and] we need to be absorbing that into our estimate. Long-term, things should revert to a more normal health care cost trend, or annual increase.”
Fidelity’s estimate assumes that both members of the couple are enrolled in traditional Medicare, which between Medicare Part A and Part B covers expenses such as hospital stays, doctor visits and services, physical therapy and lab tests, and in Medicare Part D, which covers prescription drugs.
The health care cost estimate release also finds that “Americans are generally out of sync with the expected total cost of health care in retirement.” Fidelity’s research shows that, on average, Americans estimate a couple retiring this year will spend just $41,000 on health care expenses in retirement, and 68% expect that associated costs will remain under $25,000.
The nature of for-profit health care in the U.S. is one reason costs have increased, Manion explains. “This number is going to just keep increasing until we get some fundamental change to the U.S. health care system,” she says. “It’s a for-profit system.”
Fidelity promotes health savings accounts as a solution for expected health care costs in retirement. Individuals with access to a high-deductible health plan paired with a health savings account can benefit from the triple-tax advantages of the investment vehicle to save for future medical expenses.
“There continues to be an opportunity for additional education on the power of a health savings account, especially for younger people who likely have decades to save and invest before they retire,” adds Manion. “Furthermore, HSAs are also a great way to cover current qualified medical expenses.”
Health care costs are top of mind for every retiree or anyone who is nearing retirement. According to T. Rowe Price’s Retirement Savings and Spending study (2021), the top three spending concerns of retirees are (in order of importance): paying for long-term care services, health insurance premiums, and out-of-pocket health care expenses.1
The projected health care costs in retirement provided by some of the leading experts sound alarming. In its latest (2022) projection, the Employee Benefit Research Institute (EBRI) estimates that to have a 90% chance of covering all their health insurance premiums and out-of-pocket costs, a 65-year-old couple will need $296,000.2 And according to the most recent (2010) estimates from the Boston College Center for Retirement Research (CRR), a typical 65-year-old couple can expect to spend $197,000 over their remaining lifetime with a 5% chance that the number exceeds $311,000.3 These numbers don't include long-term care costs, which could be catastrophic in some cases.
While these numbers offer a good idea of how expensive retirement health care could be over several decades, they are not very helpful for individual financial planning. Here’s why:
- Lump-sum estimates of health care costs covering the entire duration of retirement are not useful for budgeting and planning purposes because health care expenses are not incurred as lump sums. Individuals have to make their health care decisions based on their financial resources at any given point in time.
- There are embedded health insurance coverage assumptions in most of these calculations. Health insurance coverage varies significantly for retired Americans, even under the broad umbrella of Medicare. It is not clear if any particular type of health insurance coverage can be termed as "typical."
- Combining premiums and out-of-pocket costs tends to distort the perception of the risk of health care costs in retirement and complicates the associated financial planning. Premiums are relatively stable at the individual level, but out-of-pocket costs are more uncertain and, as a result, accounts for most of the variation in health care costs. Premiums also constitute the bulk of their health care expenses for the majority of retirees. As a result, for most retirees, a large chunk of their annual health care costs is predictable and can be easily planned for, a fact masked by the combined lifetime health care cost estimates.
By separating the premiums and out-of-pocket costs, retirees will be able to plan better for these expenses. Premiums, similar to other monthly expenses, like a cable or utility bill, are often paid from monthly income. On the other hand, out-of-pocket expenses are much more likely to be funded from savings.
As a result, we believe that framing health care costs in retirement should be based on (at least) three factors:
- Annual costs
- Type of health insurance coverage
- Separation of premiums and out-of-pocket expenses
From an individual perspective, the more personalized the estimates are, the better. To that effect, a host of other factors (like income, age, health status, marital status, state of residence, etc.) can be added to this framework. But since it is not always possible to reliably estimate retiree health care costs using all these factors, we think our three factor approach is a reasonable basic framework to estimate health care costs in retirement. Also, presenting a detailed picture of the distribution of these costs—rather than single summary measures like averages—addresses some of the personalization needs. For example, someone in excellent health might expect to be in the bottom quartile of out-of-pocket expenses, while someone with one or more serious chronic conditions might find themselves in the top decile of out-of-pocket expenses.
For the purposes of this research, we chose not to include the cost of long-term care. Although a majority of individuals do not incur out-of-pocket long-term care expenses during their retirement years, it could be catastrophic for a small fraction of retirees.4 The uncertainty of incurring any out-of-pocket long-term care expenses combined with the highly skewed distribution of long-term care expenses makes it very difficult to plan for them.
But there are a couple of ways people can prepare for long-term care expenses. Buying long-term care insurance could be a solution. There are a number of factors that could influence the decision to purchase long-term care insurance, including premiums (which could be very high), the level of assets an individual wants to protect, bankruptcy concerns about insurers, and the lack of caregivers. The other way is to self-insure using personal savings and then depend on Medicaid if assets are exhausted.
Below, we discuss in more detail why it is important to use annual costs, type of health insurance coverage, and separation of premiums and out-of-pocket expenses for a basic framing of retiree health care costs. Then, using this framework, we present health care cost estimates based on data from the Health and Retirement Study (HRS)5 and 2022 Medicare premiums. We also provide some guidelines on how individuals can plan to meet these expenses.
How to Plan for Health Care Expenses
It is clear that depending on what type of health insurance coverage an individual selects, health care expenses could be very different in both total health care expenses and the mix of premiums and out-of-pocket expenses. So this framework could be very useful to help individuals plan for their health care expenses based on the type of coverage they have.
Since, health insurance premiums are known in advance and can be easily included in the budget or income plan, retirees might be better served by planning to pay them from their monthly income, which might include Social Security benefits, pension payments, other annuity payments, systematic withdrawals from retirement accounts, etc. and use a dedicated pool of assets like a savings account earmarked for out-of-pocket expenses.
How much savings should
someone have available at any point in time to meet the out-of-pocket costs? A safe strategy could be to hold the amount indicated by the 90th percentiles. For example, if someone with an MA-PD plan keeps $4,000 for annual out-of-pocket expenses, chances are that in 9 out of 10 situations, she will be able to cover those expenses. Depending on the individual’s health care needs and risk tolerance, the savings amount can be increased or decreased.
More importantly, the advantage of this approach is that one does not have to hold enormously large sums in savings accounts in advance of retirement, and as a result, forgo investment or interest earnings. After allocating for the annual out-of-pocket health care expense needs, retirees can keep the rest of their assets invested and benefit from potential returns to meet their other needs, including long-term care.
The most tax-advantaged way to save for retirement health care costs is through a Health Savings Account (HSA).12 HSAs are triple tax-advantaged, i.e., income is not taxed when contributed to an HSA, investments grow tax-deferred, and withdrawals are tax-free if the funds are used for qualified medical expenses. You can pay Medicare premiums (but not Medigap premiums) and qualified out-of-pocket expenses with tax-free withdrawals from your HSA. If you are currently saving for retirement and have access to an HSA, you might consider using it for long-term investment purposes. If you are already retired and have some money in an HSA, consider keeping a portion of your HSA in cash to pay for near-term qualified health care expenses.