It's time for a new perspective.
A recent survey from T. Rowe Price found that retirees list health care costs as their top spending concern. That’s not surprising: Some studies predict that a 65-year-old couple may need up to $400,0001 to cover those costs in retirement.
We believe, however, that there’s a more effective—and less intimidating—way to calculate and plan for future retiree health care expenses. Consider these three factors:
1. Health care isn’t a one-time, bulk expense.
It’s more practical to look at health care as an annual expense incurred over 20–30 years than as a lump sum. For example, a couple might spend a total of $86,000 for cable TV in retirement.2 But when budgeting, they’d consider it a monthly expense of about $150, not a single large payment. The same holds true for health care.
2. Separate premiums from out-of-pocket expenses.
Premiums are relatively stable. As Figure 1 shows, Medicare premiums with prescription drug coverage account for nearly 75% of annual costs for the majority of retirees, no matter what type of coverage they have.
(Fig. 1) A Look at the Share of Premiums in Total Annual Health Care Costs
Median percentage share of individual health insurance premiums (ages 65 and above).
Source: T. Rowe Price estimate based on projected 2019 Medicare premiums and data from the Health and Retirement Study (HRS).
Since fixed monthly premiums make up the bulk of annual costs, most of those costs are predictable—and can be budgeted, and paid for, from monthly income.
It’s the out-of-pocket expenses that can vary widely, from month to month and from individual to individual (see Figure 2).
(Fig. 2) Out-of-Pocket Expenses Are Highly Variable
Different percentiles of annual out-of-pocket expenses for individuals ages 65 and above under different types of Medicare coverage.
Source: T. Rowe Price estimates based on projected 2019 Medicare premiums and data from the HRS.
All costs are rounded up to the nearest hundred.
We suggest maintaining a liquid fund, like a savings account, with enough money to meet out-of-pocket expenses. Replenished annually, this fund can help retirees cope with out-of-pocket uncertainties.
3. Don’t get caught up in one large number.
Most estimates assume a single type of coverage, which may actually be different for each retiree. The astronomical numbers we often see are usually skewed by an unfortunate few who pay very high expenses over a long period. That won’t be the case for most retirees.
As the chart above shows, half of retirees who have traditional Medicare (Parts A and B), a prescription drug plan (Part D) and Medigap will spend less than $1,110 a year on out-of-pocket expenses. Only one in 10 will likely spend more than $4,500, and, and it’s unlikely they’ll keep paying that much over the rest of their lifetime.