When we ask employees about their financial security, they tell us their number one stressor is not saving enough for retirement. After that, they worry about the economy and after that, their personal health. But when we ask them what defines a good lifestyle once they stop working and what is the most important factor affecting financial security in retirement, they place health at the top of both lists. Meanwhile, as another survey has found, retirees are feeling less confident that they will be able to afford medical care and long-term care.
It’s hard to know how much savings will be needed to cover healthcare expenses in retirement. The conventional approach of estimating a lifetime total cost for healthcare expenses in retirement and targeting savings to cover that amount clearly does not work for everyone, as most people have difficulty saving for retirement at all. We believe that a different approach to planning for healthcare costs may work better for most employees and retirees.
In collaboration with Vanguard, we have developed a new framework that helps pre-retirees and retirees better understand the financial planning implications of annual health care costs and long-term care expenses. Instead of a “big scary number” for the lifetime total cost, this framework considers healthcare costs (other than for long-term care) as annual expenses personalized to an individual’s health status, coverage choices, retirement age, and presence of any employer subsidies. Additionally, the framework allows pre-retirees to compare their healthcare costs in retirement to their cost while working, with the key point being that retiree healthcare costs can be viewed as the incremental cost over what they currently pay. Once an individual understands their costs, they may need to save at higher rates to account for potential future incremental health care spending. Workers with generous employer health care benefits that may not be offered in retirement and those at higher risk of chronic conditions because of their family history or current health status should target higher replacement ratios. Long-term care costs represent a separate planning challenge given the wide distribution of potential outcomes. Half of individuals will incur no long-term care costs—but there is a small but meaningful risk that costly care will be required for multiple years.
The model we have developed with Vanguard takes a fresh look at existing industry data, complements it with new findings, and builds a forecast that more clearly identifies variations in the estimated annual healthcare costs expected in retirement. We think this flexible, actionable approach to framing healthcare cost can lead to better planning and better outcomes for retirees.
Given how important this issue is to employees, consider helping your pre-retirees better understand how their healthcare costs will change in retirement and actions they can take now to save for those costs appropriately (for example, in a 401(k) plan or health savings account). A particular concern for many employees is being able to retire before age 65 and becoming eligible for Medicare. A good financial wellness program should stress that access to affordable, comprehensive retiree coverage to bridge from the active plan to Medicare is a critical issue in retirement planning.