We are all painfully aware that health care costs in the U.S. are already very high and continue to skyrocket. The dual effect of increasing costs and requiring more medical services as we age, makes it critically important to model health care costs explicitly when planning for retirement.
MoneyBee looks up the average health premium in the city where you plan to retire and suggests it as a default. Then it increases it with health care age inflation and health care price inflation, both based on data-driven models.
While no financial forecast can be 100% accurate, this approach should be sufficiently robust to give you the peace of mind that one of the most important financial aspects in retirement is properly accounted for.
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 U.S. spend on average twice as much on health insurance premiums than on out-of-pocket medical expenses. 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 health care costs.
Out-of-pocket expenses can also be forecasted - you just have to leave a little extra room for the potential volatility. These costs are less predictable compared to the relatively stable cost of health insurance 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 major component of your health care costs in retirement.
Please note that the discussion below gets a little rigorous and academic as we want to have a full disclosure of what MoneyBee does under the hood when forecasting your health care costs. While you will be able to control some of the parameters in this forecast, MoneyBee's health care cost projection is fully automated by default. You don't need to understand our math to use our calculator.
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 2023 monthly health insurance 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||$1,221|
|Santa Barbara, CA||$1,222|
|San Diego, CA||$817|
|Des Moines, IA||$969|
These prices might be a bit steep for most people looking to retire early, especially considering they may be double this amount for a couple. Furthermore, these premiums will grow every year with health care age inflation (older people pay higher premiums) and health care 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!
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, a few years of this kind of health care expense might be manageable.
Also, we still have the premium tax credit, 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.
The amount of your premium tax credit 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 until age 65), their taxable income between ages 61 and 65 may be zero and their premium tax credit may 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.
In return for these restrictions, they will receive over $100,000 worth of total benefits over the course of four years!
So how would that work in a retirement calculator?
MoneyBee automatically looks up your benchmark premium in the area where you plan to retire. This is the premium of the second cheapest silver plan you would get from a local exchange, if you bought one this year. It uses this premium by default, but you can override it if you plan to get a more generous coverage. MoneyBee then projects this current dollar premium forward with health care age inflation and health care price inflation.
MoneyBee derives its health care age inflation assumption from current premiums. Here are the 2023 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):
MoneyBee's default health care price inflation assumption is based on historical data, which is abundantly available. According to this article, price inflation for medical care (tracked by the U.S. Bureau of Labor Statistics since 1947) averaged 3.44% per year between 2000 and 2019.
Combining these health care age and price inflation assumptions, MoneyBee 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 the Sept 2022 report by the U.S. Bureau of Labor Statistics, the average expenditure on health insurance among people older than 65 is $244 per person per month. This is quite a drop from the $1,035 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 only with health care price inflation.
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 U.S. Bureau of Labor Statistics, and a fitted regression 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 $110 a month on out-of-pocket expenses, or less than 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 health care price inflation and health care age inflation. While the health care price inflation is the same across all medical expenses, MoneyBee uses a separate assumption for the age inflation in your out-of-pocket expenses. Using the same BLS data, we derived the following age inflation rates for out-of-pocket expenses:
|20 to 29||8.4%|
|30 to 39||4.6%|
|40 to 49||-2.9%|
|50 to 59||3.4%|
|60 to 64||3.3%|
(due to Medicare kicking in)
For your convenience, MoneyBee automatically looks up the average out-of-pocket expense for your current age and allows you to override it with your own current out-of-pocket expense. It then projects this amount to your retirement years with the above 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 out-of-pocket expenses during those 30 years."
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 an "event" in MoneyBee. An 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.
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.