Forecasting Health Care Costs in Retirement

Our free retirement calculator uses data-driven models to forecast your health care costs, both pre- and post-Medicare. Estimates premium tax credits too.


Retirement Calculator With Health Care Costs

When can you retire? The uncertainty about health care 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 health care 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 considered 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.


The cost of post-retirement health care

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. 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 of the major components of your health care expenses in retirement.

Pre-Medicare health premiums (if you retire prior to age 65)

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 2022 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):

CityPremium
(per month, per person)
Sonora, CA$1,219
San Francisco, CA$1,180
Santa Barbara, CA$1,183
San Diego, CA$821
Honolulu, HI$1,051
Miami, FL$987
Stamford, CT$1,391
Charlotte, NC$1,174
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 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 will be zero and their premium tax credit 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.

In return for these limitations, 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 2022 benchmark premiums in Des Moines, IA for ages 61-64:

AgePremium
(per month, per person)
61$1,075
62$1,099
63$1,130
64$1,148

This gives the following age inflation rates (for this geographic area):

AgeAge inflation
(per year)
622.2%
632.8%
641.6%

MoneyBee's default health care price inflation assumption is 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.

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.

Post-Medicare health premiums

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 2020 report by the US Bureau of Labor Statistics, the average expenditure on health insurance among people older than 65 is $238 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 health care price inflation (same as above).

Out-of-pocket medical expenses

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:

AgeOut-of-pocket
(per person, per year)
20$197
30$510
40$598
50$743
60$924
70$1,012
80$1,140

This means that the average 80-year-old spends only $95 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 (premiums as well as out-of-pocket 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:

AgeAge inflation
(per year)
Under 204%
20 to 2910%
30 to 391.6%
40 to 492.2%
50 to 592.2%
60 to 643.2%
65-9%
(due to Medicare kicking in)
Over 651.2%

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 reasonable, data-driven 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.

Conclusion

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.