Retirement planning can be devilishly difficult. It requires you to think about what your life will look like many years ahead, trade-off spending today for spending in the future and, at some level, face mortality - all endeavors most of us would rather avoid. One of the biggest challenges is forecasting your spending. A standard rule of thumb assumes people need about 70%-80% of their current income in retirement. This estimate can be misleading for two reasons. First, retirement spending levels are highly individual. Second, spending tends to vary a great deal over the course of retirement. In general, many studies have found spending follows a U curve. In the early stages of retirement, individuals spend more on things like travel. Spending tends to then fall in mid-retirement before picking up later in life when health care expenses tend to ramp.
Regardless of what your specific spending “trajectory” looks like, you can be sure of one thing. Healthcare costs are likely to eat up an ever larger share of retirement income in the years ahead. In 2015, the Employee Benefit Research Institute estimated that a 65 year old couple with median drug expenses would need a total of $158,000 to have a 50% chance of covering their medical expenses. But couples with high drug costs would need just under $400,000 to have a 90% chance of covering costs. What about Medicare, you say? This health insurance program, which covers 95% of Americans over 65, eats up 14% of the federal budget but covers only a little more than one-fifth of total personal health expenditures.
Traditional Medicare includes Part A and Part B. Part A covers inpatient hospital, skilled nursing facility, some home health visits and hospice care. Part B helps pay for physician, outpatient, some home health and preventative services. These two programs, however, do not cover many of the costs that the elderly incur including those relating to prescriptions, long term services or support, dental or vision care and hearing aids. Private insurers offer a standard range of supplemental plans (numbered C-N) to bridge the funding gap. In addition to researching plan options, those approaching retirement should keep one key rule in mind. To avoid paying a penalty, most individuals must sign up for Part A within 90 days of turning 65 .
While you cannot predict your healthcare spending in retirement, you can project out what you are likely to pay in premiums. Most beneficiaries do not pay a premium for Part A but are required to pay deductibles and co-insurance fees for some covered services. Participants are generally required to pay a monthly premium for Part B coverage and these levies are means-tested (i.e, those in higher income brackets pay larger premiums). Most people covered under the “traditional” A&B plans obtain some type of private supplemental coverage to help cover out-of-pocket costs (Medigap policies). Monthly premiums for Part B, D (drug coverage) and F, the most comprehensive supplemental plan, are likely to range between $300 per person for those with incomes less than $170,000 (married filing jointly) to $600 per person for those in higher income brackets. Medicare Advantage plans, used by approximately one-third of retirees, provide a somewhat more affordable option but require participants to use in-network providers for care.
Current estimates hold that the Medicare Part A Trust Fund is set to become insolvent in 2028 if current spending rates hold. Efforts to place the program on more solid footing, everything from raising the eligibility age for Medicare to privatizing the system, have made little progress so far. The funding shortfall cannot be put off indefinitely, however, and when it is addressed, you can be sure that your pocketbook will be part of the solution.