retirement savings  |  january 7, 2022

Podcast: Don’t Fear Retirement Health Care Costs

Listen to a discussion on the potential range of health care expenses so you can better manage your retirement expenses.


You’ve seen the estimates that it will cost over $400,000 to pay for health care in retirement, but is that necessarily your reality? Our experts, Sudipto Banerjee, Ph.D., and Stuart Ritter, a CERTIFIED FINANCIAL PLANNER TM professional, discuss the potential range of health care costs, so you can better manage your retirement expenses.
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Michael Davis: Welcome to T. Rowe Price's CONFIDENT CONVERSATIONSTM on Retirement. My name is Michael Davis, and I'm thrilled to be your host. I've spent my career working to help people build a durable retirement. It is such an honor to do this work and an even greater privilege to be with the retirement experts here with us today. These professionals can help you feel more confident about your own retirement, whether you're planning for retirement or already there.

Today, we're talking about health care costs in retirement. I'm joined by T. Rowe Price experts, Stuart Ritter, a CERTIFIED FINANCIAL PLANNERTM and frequent speaker on retirement topics, and Sudipto Banerjee, a Ph.D. economist who has done extensive research on retiree health care costs. Welcome to the show, gentlemen.

Stuart Ritter: Thanks, Michael. It's great to be here.

Sudipto Banerjee: Yeah. Thanks.

Michael Davis: Great to have you here. As you know, health care costs are a major concern for retirement savers, and we've all seen the research that suggests that retirement health care costs are projected to be a six-figure expense for the average retiree. Now that can be a very scary number for a lot of people and can certainly be a real confidence killer. Is there a way to think about this challenge so it doesn't feel so overwhelming? Stuart, why don't you kick us off?

Stuart Ritter: Sure. Let me make the point that health care is not a six-figure word. I'm thrilled we're doing this podcast, because one of the things that's going on when it comes to what people hear about the cost of health care in retirement is, to some degree, people are vying for airtime. They're vying for eyeballs. It's like the weather forecasters who realize, "Well, you know if I predict there might be an inch of snow, I might not get so much attention. But if I say there's going to be two feet, well then a lot of people will pay attention." Some of that is happening when you hear these six-figure numbers, when it comes to what retirees are paying for health care costs. And as a result, a lot of people start believing that every person who reaches retirement is going to have to pay a six-figure dollar amount for their health care costs in retirement. I'll give you three reasons why health care costs in retirement are not a big, scary number. The first reason they're not a big, scary number is because they're not a lump sum.

Nobody shows up at your door the day you retire and says, "Okay, pay for one of your retirement expenses all in advance today." Nobody says, "Well, you know if you pay about $150 for your cable bill, your internet access, well, if you do some math, that works out to about $86,000. So write us a check for $86,000 today." That's not how you pay your cable or internet bill. That's not how you pay for your health care costs.

You don't pay them as a lump sum the day you retire. You pay them as an ongoing annual amount that happens throughout your entire retirement. So, the first reason it's not a big scary number is that it's not a lump sum. The second reason is that “you” is not “we.” Those numbers you see in the headlines in almost all cases are for a couple. And yet a lot of individuals will think that's what I personally need to pay for this health care cost expense that I'm going to encounter, when in reality, those numbers are talking about two people. And the third reason it's not a big scary number–and I'd argue the biggest reason–is that those numbers you see are not even remotely average. They're not what the typical retiree experience is when it comes to health care costs in retirement.

For example, let me give you the methodology that was used to create one of those six-figure numbers. What somebody did is they took all the expenses that all retirees pay for their medical costs, and they lined them up from the smallest amount to the largest amount. And they picked the number that was higher than what 90% of all the retirees pay for their medical costs. And then they went and did the same thing with prescription drug costs. And then they added those two numbers together, even though that's not the same person. So putting out a number that's higher than what nine out of 10 retirees pay is not giving people a clear representation of what the typical retiree experience is, what the average retiree experience is. So certainly, those numbers are out there; they get a lot of attention, but it's helpful for people to realize that might not be, and actually in most cases won't be, my personal experience.

Michael Davis: Sudipto, do you have anything to add to that?

Sudipto Banerjee: Yeah, sure. So let me just add to a couple of things to what Stuart said, which is so Stuart mentioned about the lump sum, how it is not a lump sum. There are some other things going on in some of these estimates that are a kind of little bit in the weeds, but we need to know that because then we know how to have a better estimate... a better understanding of these costs. So, for example, again, most of these estimates would assume that everyone has a particular type of health insurance. So, we know that every retiree has Medicare, but even within the broad umbrella of Medicare, there are different variations. So, there is the traditional Medicare, and you can add a drug plan to that. And then there is Medicare Advantage, which is the private plans. And then even if you have traditional Medicare, then you can add a Medigap plan to it.

And all these different plans have very different cost implications. Now, when you look into these estimates, they would almost always assume that everyone has one kind of a plan. Like in many cases, they would just assume that everyone has got traditional Medicare plus Medigap, which is, incidentally, the most costly plan.

And we know that not everyone would have that Medigap plan, so people have different plans with different costs. So, that's another reason why we should be a little bit wary about using these numbers. So, what we have worked on for the last few years is to come up with an approach of our own, which we think it provides a much better understanding and a better estimate of what retirees might actually face in terms of their health care costs.

Our approach is based on three factors. So, the first one is, as Stuart was mentioning, the lump sum. So we don't provide lump-sum estimates. So, we see these costs, more or less, as an annual expense. That's why our estimates are based on what a person might expect to spend in any one given year. And then we provide a range of estimates for different kinds of health insurance plans so that people, based on whatever plans they have, they can see what their costs might be. And the final thing in our approach is that we separate out premiums and out-of-pocket expenses. So premiums are essentially fixed expenses that a retiree incurs every month.

On the other hand, out-of-pocket expenses vary a lot. It's very different how you plan for premiums and out-of-pocket expenses. Your premiums are fixed; you know this. You can adjust... you can pay for it from your monthly income stream. Whereas for out-of-pocket expenses, it more or less requires you to have some sort of liquid savings because you don't know when you will need it and how much you will need it.

Michael Davis: Media reports project large amounts of health care-related costs in retirement, and you see estimates like $400,000 or more. Based on what you've said, it sounds like that is not the estimate people should work from, but I would take your thoughts on this. Is that the estimate people should use? And I'll go to you, Stuart.

Stuart Ritter: One of the things we run into when people are thinking about retirement health care costs is they see those big numbers out there and don't really associate a probability with it. Everyone assumes, okay, they're saying it could be as much as a six-figure number. I need to plan on that. And it's helpful for people to recognize kind of the range of expenses that people encounter and then the likelihood of coming up with any particular number.

So one of the ways to think about it is imagine you have a deck of cards. And you lay out the deck of cards by suit. You've got spades, clubs, diamonds, and hearts, left to right. If I drew a line where half the cards were to the left of that line, where it was all the black cards, that would be what we call the 50th percentile. 50% of the time, if you shuffle the deck of cards, you get a black card when you choose one at random.

When we look at the total health care spending, the annual total health care spending for retirees–the dollar amount where half of retirees are spending that amount or less is $3,400... $3,400. Half of retirees spend that amount or less. It's as if they're shuffling a deck of cards. They pull a random card out, and if they get a black card, they're paying $3,400 or less.

Now, if they get a red card, they're paying more than that. So, this starts helping people realize it's not guaranteed that everybody has to pay these six-figure numbers. So understanding that there's a range of numbers and the probability of where you might fall in that range helps people start thinking about it more as a manageable number that they can bake into the overall holistic retirement planning that they're already doing, as Sudipto pointed out for your ongoing, fairly steady premium costs, the fixed costs. That's something you're going to put in your budget just as you might put in a housing expense, a utility bill, putting gas in your car.

The out-of-pocket expenses, those you would manage differently. Again, as Sudipto mentioned, you've got a balance somewhere, you probably pay for it out of that. But recognizing that there's this range that you're going to deal with... that helps people put it in perspective.

Sudipto Banerjee: And, Michael, I just wanted to add a couple of other points just again, to emphasize Stuart's points on the range and why we don't focus on one single number.

So Stuart gave one number, which is the median, that 50% people will spend less than that and 50% will spend more than that, which is about $3,400. So that is an estimate for people with traditional Medicare and a prescription drug plan. But what happens for people who have traditional Medicare with Medigap and a drug plan? I think that number is about $6,500. So you can see immediately that how having a different plan changes the range.

Another reason why we provide this range of estimates is that people have different health conditions. We provide the median, and then we provide the 90th percentile. So someone who is in excellent health might think, "Okay, the average is a good estimate for me." Whereas someone who has one or two underlying conditions might look at some of these upper estimates and think, "Maybe my expenses might be closer to that than the typical average expenses." So, for all these reasons, we provide a range of estimates.

Stuart Ritter: Yeah, you'll notice that all the numbers we've thrown out don't come close to a six-figure dollar amount.

Michael Davis: I noticed that. And I think the way you framed it... I think makes the understanding of these costs much more understandable and much less overwhelming. So how should people plan for these costs?

Sudipto Banerjee: In many cases, for example, Medicare premiums are deducted from Social Security anyways. And then if you have other premiums, so if you have a Part D plan or you have a Medigap plan, or you have some sort of other plan for which you need to pay monthly premiums, you should have your monthly retirement income plan constructed in a way so that it takes into account that premium.

On the other hand, out-of-pocket expenses varies a lot. For someone who is in very good health might not have almost any out-of-pocket costs in a month or sometimes maybe in a given year. But someone with average health will definitely incur some costs. And someone in bad health will have significant costs. So we provide these different estimates. So, what people might use this estimate for is to get an idea of how much liquid savings they should hold at any point. So, you don't need to hold, like, that $400,000 or $200,000 always in your savings account. So, just have enough in your savings so that you can pay for your out-of-pocket expenses.

Stuart Ritter: Let me provide some context that can give people some additional perspective on where the health care spending fits in the broader context of overall retiree spending. The Bureau of Labor Statistics goes out every couple of years and does a consumer expenditure survey where they ask people really detailed questions about what they spend their money on–everything from how much did you spend on dairy products to motor oil. And they put that spending into different categories. When you look at the results of that, and we looked at what spending by people over age 75 looked like. So, we even took early retirees out of it. When you look at the spending for people over age 75, the number one category of spending was housing, not health care. People spend about... 36% of their spending goes to housing. Health care is second at 16%. So, when you look at everybody together, health care is the second biggest expense by less than half of what people are spending on the number one expense of housing. So just to give people a little more context around it, recognize that health care isn't some separate category that you've got to deal with off by itself, that it fits in with the overall holistic planning you're doing.

Michael Davis: One of the biggest fears people have about health care spending in retirement are nursing home costs. Should they be concerned? And I'll start with Sudipto.

Sudipto Banerjee: Nursing home, it could be a cause of concern because some of the big numbers that come out for health care costs are really a result of long nursing home stays. So, we looked into what are the chances that someone might enter into a nursing home in, say, the last two years of their lives? Because that's when most people will need that type of care. So, when we looked at people who died very young ages, ages 65 to 69, we saw that there was about close to 18% chance of someone entering a nursing home. But that goes up steadily as people age. So someone dying at the age of after 90... that probability goes up to more than 60%. But then there's also the question of, if not just entering a nursing home, how long someone is staying in the nursing home, because that's what really determines the cost. And, again, we see that there is a lot of variation there. So, we saw about 38% of people who entered nursing homes in the last two years had stays of less than a month. And about 14% had stays of over two years.

And then, finally, when we looked into the costs–what were their out-of-pocket costs–again we looked at different five-year age bands, and we saw, for example, people who died between 80 and 84. So their median out-of-pocket costs for nursing home care was zero. So, the average person did not have any out-of-pocket nursing home costs. But the 95th percentile–which means that 5% spent more than this amount–was at about $23,500. But then when we go to older retirees, people who lived up to 90 and more... again, the median was still zero. So even people who are living that long, the average person in that group is not incurring any out-of-pocket costs for nursing home expenses. But the 95% percentile are, again, 5% of that group spent more than $94,000 in nursing home costs. Let me give you some context of that $94,000 number. So, we are talking about people who lived longer than 90, and only 5% in that group had that expense.

Again, when you look into these nursing home costs, there is a very small probability that someone might end up paying those costs. But how do you want to prepare for this? It's up to the individual because we always have Medicaid. If someone runs out of money, they might go under Medicaid, and Medicaid will take care of that. But whether you want to have enough private assets to fund those nursing home costs, that's up to every individual.

Stuart Ritter: And here's a way to think about the $94,000 that Sudipto is talking about: If you're 65 years old and you're concerned about encountering that $94,000 nursing home expense that Sudipto was talking about, two things have to happen. First, you have to have an expense that's higher than what 95% of all the other people in their 90s experienced.

And second, you need to live to your 90s in the first place. And there's only about a one-third chance that a 65-year-old female will live to age 95, a one in four chance that a 65-year-old male will live to age 95. So is that expense out there? Absolutely. We're not saying it doesn't exist. What we are trying to do is help people understand the probability, the likelihood that they might experience it, and when it will incur. Most of the big numbers that you see are incurred by people later in life, usually in their late 90s.

Michael Davis: Finally, the biggest fear of all, as we know, is that people could be bankrupted by health care spending and run out of money in retirement. That's a fear that a lot of people have. Is that a common occurrence, Stuart?

Stuart Ritter: It is not. Understandably, the concern that health care costs are going to use up all of someone's money, especially if they have somebody else in their household who would rely on that money, is a legitimate concern. But similar to all the things that we've been talking about, when you look at the median, the percentage of net worth that's used up at the end of life–so the last two years of somebody's life–is in the low single digits. So, when someone passes away, their health care expenses in those last two years have used up two or 3% of the household net worth. It's only, again, when you've got somebody that has an expense that's higher than what 95% of everybody else at their age group experiences, and if someone is in their 90s, that you see really substantial percentages of the household net worth being used up.

Michael Davis: This has been a terrific discussion. It would be great to get your final thoughts and takeaways from the conversation that we've had. And I'll start with Sudipto.

Sudipto Banerjee: Yeah. I would say that don't focus on that lump-sum number. It is not really relevant from any perspective. It does not relate to your personal situation, and it's not helpful for planning.

Michael Davis: How about you, Stuart?

Stuart Ritter: We can probably all think of someone who's paying a large amount for health care or especially for long-term care expenses. But I would submit that the person we can think of is actually the exception that proves the rule. There are over 50 million people over age 65. So the fact that we can think of one or two people actually points out and highlights that most people don't have those six-figure dollar amounts. Hopefully when you recognize that and recognize the range of outcomes, the probabilities that you might experience them, they're still very unlikely, can help people feel more confident that they're prepared for retiree health care costs, and will be able to manage them no matter what may be in the cards for them.

Michael Davis: What next steps would you recommend our listeners take? I'll start with you, Stuart.

Stuart Ritter: I think the best thing people can do is start incorporating retiree health care costs into their overall retirement planning. Don't treat health care like something separate. Work it into the budget you're already creating, and that'll make you feel more confident that you've got a plan in place to help you with this.

Michael Davis: How about you, Sudipto?

Sudipto Banerjee: So, for people who are close to retirement, I would say definitely focus on filing your Medicare claims timely because that could have important permanent implications. That's a key decision that people need to make, get that right.

Michael Davis: Terrific. We're at the end of our time. I want to thank you both so much for joining us today. It's been a terrific conversation. And if you would like to hear more from Sudipto or Stuart, check out their podcast episode on retiree spending. Again, I'm Michael Davis, and I want to thank you for listening. Be sure to join us for our next episode, where we discuss how much cash you will need in retirement. If you like this podcast, please rate us and subscribe to wherever you get your podcasts. Until next time, be well, and I wish you all many confident tomorrows to come.

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