Health Care

A New Way to Calculate Retirement Health Care Costs

Separating premiums and out-of-pocket costs makes it easier to plan for expenses.
Key Insights

  • Viewing retirement health care costs as an annual expense, instead of as a lump sum, makes it easier for retirees to plan for and pay for them.
  • Health insurance premiums  are usually fixed and can be budgeted for monthly, while out-of-pocket expenses can vary and could be paid from savings and other sources.
  • Retirement health care costs can vary widely, depending on the type of insurance a retiree chooses. Useful estimates should focus on the type of insurance coverage.

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 (2023), the top two spending concerns of retirees are (in order of importance): paying for long-term care services 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 (2024) 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 $351,000.2  This number does not 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:

  1. 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.

  2. 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."

  3. 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, account 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 (such as 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.3 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.

Download the full article below, where we discuss in more detail why it is important to use annual costs, the types of health insurance coverage, and the 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)4 and 2024 Medicare premiums. We also provide some guidelines on how individuals can plan to meet these expenses. 

Download the full article

A New Way to Calculate Retirement Health Care Costs

Separating premiums and out-of-pocket costs makes it easier to plan for expenses

The Retirement Savings and Spending (RSS) study is a nationally representative annual survey of 401(k) plan participants and retirees. The survey has been fielded annually since 2014. The 2023 survey was conducted between July 24 and August 13, 2023. It included 3,041 401(k) participants, full-time or part-time workers who never retired, currently age 18 or older, and either contributing to a 401(k) plan or eligible to contribute and have a balance of $1,000+. The survey also included 1,176 retirees who have retired with a Rollover IRA or 401(k) balance.

Fronstin, Paul and Jack Spiegel. “Projected Savings Medicare Beneficiaries Need for Health Expenses Increased Again in 2023,” EBRI Issue Brief (January 18, 2024).

Banerjee, Sudipto. “Cumulative Out-of-Pocket Health Care Expenses After the Age of 70,” EBRI Issue Brief, no. 446 (Employee Benefit Research Institute, April 3, 2018).

4 Health and Retirement Study, public use dataset. Produced and distributed by the University of Michigan with funding from the National Institute on Aging (grant number NIA U01AG009740). Ann Arbor, MI.

Important Information

This material is provided for general and educational purposes only, and not intended to provide legal, tax or investment advice. This material does not provide recommendations concerning investments, investment strategies or account types; and not intended to suggest any particular investment action is appropriate for you. Please consider your own circumstances before making an investment decision.

The views contained herein are those of the authors as of February 2024 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

All investments involve risk. All charts and tables are shown for illustrative purposes only.

© 2024 T. Rowe Price. All Rights Reserved. T. Rowe Price, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.


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