When can you retire? The uncertainty about healthcare costs in retirement causes many to worry about when they can afford to retire or postpone their retirement, just to be on the safe side. We are all painfully aware that healthcare costs in the US are already very high and continue to skyrocket. The dual effect of increasing costs and requiring more medical services as we age often pushes us to delay retirement as much as possible. And retiring before you can receive Medicare is often completely out of the question.
However, with the right data-driven forecasting tools, you can get just the right amount of certainty and clarity you need to make an informed decision. While no financial forecast can be 100% accurate, you can get a reliable and conservative estimate on when it may be reasonable to retire.
Our fears usually stem from the risk of catastrophic medical expenses. But keep in mind that is exactly what health insurance is there to cover. Retirees in the US spend on average twice as much on health insurance premiums than on out-of-pocket medical expenses. This means that most of your healthcare expenses can be planned out in advance with reasonable confidence. To the extent that health premiums can be projected using data-driven models, you can get a reasonably accurate prediction of the majority of your healthcare costs.
Out-of-pocket expenses can also be forecasted - you just have to leave a little extra room for the potential volatility. This is because these costs are less predictable compared to the relatively stable cost of healthcare premiums. However, a reasonable forecast is definitely achievable here as well, if based on well-researched, age-related patterns, and medical cost trends. We will discuss below how to factor any large one-time out-of-pocket expenses you may be anticipating in retirement.
Let's take a closer look at each of the major components of your healthcare expenses in retirement.
If you retire before Medicare kicks in, you will probably want to buy health insurance on your own. As you can imagine, this can be quite expensive. Here's what the 2021 monthly healthcare premium would look like for a 61-year-old retiring in one of these areas under the second cheapest silver plan from an exchange (silver plans have middle-of-the-road coverage):
(per month, per person)
|San Francisco, CA||$1,255|
|Santa Barbara, CA||$1,234|
|San Diego, CA||$808|
|Des Moines, IA||$1,075|
These prices might be a bit steep for most people looking to retire early, especially considering they may be double this amount for a married couple. Furthermore, these premiums will grow every year with healthcare age inflation (older people pay higher premiums) and healthcare price inflation (the cost of medical services goes up with time). You can see how the cost of health insurance can quickly become out of reach for the average American family.
Now the good news — and there is some!
First, retirees have to pay these high premiums only until they turn 65 and Medicare kicks in. For those who have enough saved up for retirement, four years of this kind of healthcare expenses might be manageable.
Second, we still have Obamacare, which can pay for some or all of your pre-Medicare health premiums. There's a common misperception that this is a program for the poor. It was definitely not designed that way. A person making nearly four times the poverty guideline can still benefit from it. How much you get from Obamacare depends on your taxable income.
If the couple in our example has enough after-tax savings to live on until age 65 (and they delay starting their Social Security benefits at least until age 65), their taxable income between ages 61 and 65 will be zero and Obamacare will pay their entire health premiums during that period!
In order to be eligible for this benefit, they will have to purchase their health insurance from an exchange (which may have fewer options than private insurance) and their benefit cannot exceed the cost of the second cheapest silver plan.
However, this is a small price to pay for over $100,000 worth of total benefits over the course of four years!
So how would that work in a retirement calculator?
A good retirement calculator should be able to automatically look up your benchmark premium. This is the premium of the second cheapest silver plan you would get from an exchange in the area where you plan to retire, if you bought one today. Good calculators will also let you override it, if you plan to get a more generous coverage. Then the calculator should automatically project this current dollar premium forward with age and price inflation.
The age inflation is easy to extract from the current premiums. Here are the 2021 benchmark premiums in Des Moines, IA for ages 61-64:
(per month, per person)
This gives the following age inflation rates (for this geographic area):
The future healthcare price inflation can be based on historical data, which is abundantly available. According to the Bureau of Labor Statistics, medical costs increased on average by 3.45% per year between 2000 and 2020. This may be a reasonable assumption for future healthcare price inflation.
Combining these healthcare age and price inflation assumptions, a retirement calculator can tell, with a reasonable degree of confidence, how much your pre-Medicare health insurance will cost, if you retire before you turn 65.
Medicare, which usually kicks in at age 65, provides decent coverage for retirees. Some people choose to go even further and purchase additional coverage on their own (Medicare Supplement). According to this 2019 report by the US Bureau of Labor Statistics, the average expenditure on health insurance among people older than 65 is $233 per person per month. This is quite a drop from the $1,148 a 64-year old would have to pay in Des Moines, IA prior to Medicare.
Medicare Supplement premiums are the same across all ages (no age inflation) and need to be projected with just healthcare price inflation (see above).
Both before and after age 65, you will have some medical expenses that are not covered by your insurance — copays, deductibles, and non-covered procedures. Using the above report by the US Bureau of Labor Statistics, and a fitted mathematical model of our own, we derived the average out-of-pocket expenses for each age. Here are a few sample ages:
(per person, per year)
This means that the average 80-year-old spends only $118 a month on out-of-pocket expenses, or about half what the same person would spend on health premiums. Again, people purchase insurance precisely to avoid large and volatile out-of-pocket expenses, and that seems to be working.
Your out-of-pocket expenses will grow with both healthcare prices and age inflation. While the healthcare price inflation is the same across all medical expenses (premiums as well as out-of-pocket expenses), your retirement calculator needs a separate assumption for the age inflation in your out-of-pocket expenses. Using the same model, we derived the following age inflation rates for out-of-pocket expenses:
|20 to 29||5%|
|30 to 39||3.1%|
|40 to 49||1.4%|
|50 to 59||4.5%|
|60 to 64||5%|
(due to Medicare kicking in)
A good retirement calculator should be able to look up the average out-of-pocket expenses for your current age and allow you to override them with your own current out-of-pocket expenses. Then it should be able to project these expenses to your retirement years with reasonable, data-based assumptions for price and age inflation.
What about those $30,000 non-covered procedures we hear about all the time?
"I'm afraid that if I budget only $1,000 a year for out-of-pocket expenses, it will take me 30 years to save $30,000 for my non-covered procedure — and that's if I have no other out-of-pocket expenses during those 30 years."
First of all, from the data we are looking at, such major out-of-pocket expenses seem to be much less common than we think, especially among people covered by Medicare. That is not to say that your out-of-pocket expenses will match even the best of forecasts every year, but the deviations are very unlikely to be that large.
That said, it is always a good idea to be prudent and conservative in our assumptions about the future. We suggest you start by looking at what procedures are covered by Medicare or by a good Medicare Supplement insurance. If you still think it's likely that you will have a large non-covered procedure (because of family history, pre-existing conditions, or simply for peace of mind), you may want to set up a "special event" in your retirement calculator. A special event is a large one-time expense that will cost an amount decided by you. This way, the extra expense can become a part of your retirement plan and you can ensure the funds will be there if you need them. A good retirement calculator should also allow for special events, adjusted with inflation, precisely for this kind of situations.
While the uncertainty surrounding medical expenses will always be there, there is plenty of data available to help us develop a reasonable projection of these expenses. In some years you'll go above this projection, and in some years you'll land below. It may average out, it may not. That's why it's important to update your calculator periodically (yes, even after you retire), so that any gains or losses can be spread over the remainder of your life and you can make timely incremental changes to your plan.
Unfortunately, despite healthcare being such an important part of a retiree's economy, healthcare costs are rarely forecasted by retirement calculators using data-driven, age-adjusted models. In fact, many calculators lump your healthcare costs in your overall desired retirement income, which they ask you to input. But how would you know what retirement income you'll need, especially given that healthcare expenses vary so much with time?
If you're looking for a free retirement calculator that incorporates the forecasting methodology laid out in this article, you can try our online calculator, MoneyBee. It also automatically estimates any Obamacare subsidy you may be eligible for if you retire prior to age 65.