A key to retirement planning is anticipating how spending habits may change in later years. Housing costs, for example, may decrease if one downsizes, but other expenses may consume a larger share of retirement assets than you had planned.

Health care can be one of the biggest expenses. A 65-year-old couple retiring in 2019 can expect to spend $285,000 in healthcare and medical expenses throughout retirement. This doesn’t include the additional annual cost of long-term care, which, in 2019, ranged from $19,500 for adult day care services to $102,200 for a private room in a nursing home, according to long-term care insurer Genworth.

Despite saving and preparing for retirement their entire lives, many retirees aren't mentally or financially prepared for these expenses. “Retirees, in addition to most consumers, seem to underestimate how much they will need for health expenses in retirement, including premium and out-of-pocket costs,” says Chad Wilkins, president of HSA Bank. The majority of adults 65 and older believe they would need less than $100,000 for health care when in fact males 65 and older will need approximately $135,000—and females, $150,000—to pay for healthcare in retirement. 

Those close to retirement or already making the transition out of the workforce must understand how to plan for growing medical costs.

Key Takeaways

  • A 65-year-old newly retired couple will need $285,000 for medical expenses in retirement.
  • On average, those 65 and older spend $3,800 per month, with Social Security replacing about only 40% of their working-life income.
  • Medicare may pay for some healthcare spending in retirement but Medicare does not cover medications without a Part D prescription drug policy.

Review Retirement Income and Spending

There are two important numbers regarding healthcare expenses in retirement: How much money comes in and how much goes out.

The typical person in their 60s has an estimated median savings of $172,000. On average, those 65 and older spend $3,800 per month, Social Security replaces only about 40% of their working-life income. The Social Security Administration (SSA) estimates that the maximum monthly benefit for people who file for Social Security at full retirement would be $3,113 in 2021. That amount drops to $2,324 for anyone who claims benefits at the age of 62.

How much retirement income to budget for healthcare depends largely on one's age and overall health. “The healthier we are going into retirement typically means that less money will be allocated toward healthcare expenses,” says Chris Schaefer, head of the retirement plan practice at MV Financial in Bethesda, Maryland. “The other side of that coin is that with a healthier lifestyle, life expectancy will be longer and, therefore, retirees need to plan for a longer time in retirement.”

Two-thirds of adults 65 and older believe they'll need less than $100,000 for health care in retirement; in fact, they'll need more like $135,000 (men) and $150,000 (women).

Medicare can pay for some health care spending in retirement, but with limitations, says Michael Gerstman, founder, financial advisor CEO of Gerstman Financial Group, LLC in Dallas. “For example, without a Part D prescription drug policy, Medicare does not cover medications,” says Gerstman.

Original Medicare, also referred to as Parts A and B, won’t cover dental and vision care but Medicare Advantage plans typically do. No part of Medicare offers coverage for long-term care.

If relying on Medicare to help cover medical expenses in retirement, plan for deductibles, premiums, and out-of-pocket costs. For 2020, the standard deductible for Medicare Part A is $1,408. The standard monthly premium for Part B is $144.60, although some Medicare beneficiaries will pay less. The Part B annual deduction for 2020 is calculated at $198. The base premium for Part D coverage in 2020 is $32.74 per month, and most Part D plans have an annual deductible of up to $435.

Medicare Advantage plans are offered through private insurers who set the premiums, not the federal government as with Parts A, B, and D. Depending on the insurer and what the policy covers, one could pay more or less for a Medicare Advantage plan. These plans are offered by private companies that are approved by Medicare rather than the federal government. These plans generally cover the same costs that original Medicare does, along with Part D prescription drug coverage. Some plans may also extend coverage to include costs associated with vision, dental, and hearing.

Look Beyond Retirement Savings to Pay for Health Care

Climbing health care costs don’t have to drain your nest egg. There are two ways pre-retirees can create a safety net for health care spending in retirement.

The first is with a health savings account (HSA). These are available with high-deductible health plans (HDHP) and offer triple tax advantages:

  • Deductible contributions
  • Tax-deferred growth
  • Tax-free withdrawals for qualified medical expenses

“HSA funds can be used to pay for certain medical premiums, including Medicare premiums and long-term care insurance premiums,” Wilkins says.

Those already in their 50s can still maximize these plans by taking advantage of catch-up contributions and employer contributions. “Individuals 55 or older can make a catch-up contribution of $1,000 per year in addition to the maximum contribution limit,” Wilkins says. “Many employers will contribute cash rewards to an HSA for preventative screenings such as mammograms or annual physicals.”

For 2020, the regular HSA contribution limit is $3,550 for individual coverage and $7,100 for family coverage. These limits apply to both employee and employer contributions combined. One caveat: Those enrolled in Medicare can no longer make new contributions to an HSA.

Purchasing Long-Term Care Insurance

Purchasing long-term care insurance is another way to fill the gap left by Medicare. This type of policy can pay a monthly benefit toward long-term care for a two- to three-year period; which can help you avoid spending your assets to qualify for Medicaid, which does pay for long-term care.

Long-term care insurance premiums may not be affordable for everyone. Gerstman says an alternative is buying a life insurance policy that has the option of adding a long-term care insurance rider. “This allows younger people to get ahead in their long-term care planning,” Gerstman says, because the sooner one buys life- or long-term care insurance, the lower the premiums likely would be.

The Bottom Line

Healthcare spending can easily account for a big share of a retirement budget. Estimating those costs and creating a strategy for spending can help preserve more of your retirement assets for other expenses.