EDITOR'S NOTE: This article was originally published in the January 2012 issue of Kiplinger's Retirement Report. To subscribe, click here.
You think you've done a pretty good job calculating your expenses in retirement, from utilities to taxes, from groceries to entertainment. But how realistic is your health care line item?
This will hurt a lot: A 65-year-old couple who lives until 92 can expect to spend nearly $400,000 in out-of-pocket medical costs, assuming a 6% annual health care inflation rate, according to Fidelity Investments. What's worse, this number does not include long-term-care expenses. (Plug in your own numbers at Fidelity's calculator at https://powertools.fidelity.com/healthcost/intro.do.)
If that number seems high to you, consider that premiums for Medicare Part B, which pays for outpatient services, a Part D prescription-drug plan and a private Medigap policy can easily run a couple $6,500 a year. Add dental work, vision care, hearing aids and co-payments for drugs -- and then figure in inflation. "People are very surprised that so much of their retirement savings are going toward health care," says Sunit Patel, senior vice-president for Fidelity Benefits Consulting.
These projections are likely to send your blood pressure sky high. But there are strategies to reduce, and pay for, your medical costs if you're prepared. One of the first steps, Patel suggests, is for seniors to get a good idea of their retirement health care number as early as possible "so that they can budget for it appropriately." Two places to start are Medicare.gov, where you can review the costs of Part D and private Medicare Advantage plans, and PlanPrescriber.com to review the cost of Medigap supplemental insurance policies.
Former Boeing executive Henry "Bud" Hebeler, author of Getting Started in a Financially Secure Retirement (Wiley, $27.50), says retirees should keep a liquid reserve for all emergency expenses, including unexpected medical costs. This reserve should not be included in your retirement investment total when calculating your annual retirement spending. Your spending calculations, however, should include the costs of Medicare premiums and other expected health care expenses. (Calculate your own retirement budget on Hebeler's Web site, www.analyzenow.com.)
If you don't have a fixed income stream such as a pension, you could consider an immediate fixed-payout annuity to pay for certain essential expenses, including health care premiums and out-of-pocket drug costs. "The sleep-well-at-night factor is affected by how much guaranteed lifetime income is coming in the door," says Rebekah Barsch, vice-president for retirement strategy at Northwestern Mutual Life Insurance.
If you have a serious illness that could reduce your life expectancy, you could buy a medically underwritten immediate annuity that will provide higher monthly payouts or charge lower premiums.
With these products, also called age-rated annuities, the insurance company will boost payouts because it assumes it will make fewer of them. To qualify, you must have a serious condition, such as heart disease, vascular disease, Parkinson's or lymphoma.
Consider a policy offered by Mutual of Omaha Insurance. Based on current interest rates, a healthy 65-year-old man who spends $100,000 on an immediate annuity could receive lifetime monthly payouts of $550. If the insurer determines, based on his health, that he has a life expectancy of a 70-year-old, he could receive $635. "This is a way for somebody who has a medical condition and income needs to get more-favorable terms than if he went with the standard terms of an immediate annuity," says Yuri Veomett, product performance director at Mutual of Omaha.
To apply, you will need to submit a statement from your physician. The company will determine your expected longevity, based on the severity of your condition, Veomett says. Before you buy, ask your physician if he or she concurs with the age rating.
Here are some other strategies that could ease the pain of a severe case of swollen medical costs.
Insure the risk. A standalone long-term-care insurance policy can protect you against the huge costs of a nursing-home stay, home health care or assisted living. But many seniors balk at the idea of paying premiums for insurance that they may never need. In response, insurers are offering policies that combine life insurance or annuities with long-term-care protection.
A hybrid life insurance policy, for example, would provide a death benefit for your heirs and a pool of money you can use for long-term care. Funds used for care would reduce the death benefit. "It's not use it or lose it," says Michael Reese, a certified financial planner in Traverse City, Mich. "If I don't need long-term care, my spouse gets all the cash tax-free. And if I need long-term care, I have the money."
These products are being marketed to people between 55 and 75 who do not have traditional long-term-care insurance and may now find it too costly. One such product is Mutual of Omaha's Living Care Annuity, which is a fixed deferred annuity with a built-in long-term-care rider. Say you invest $100,000 at age 65. If, at age 75, the annuity value is $125,000 and you need long-term care, the product will pay benefits tax-free up to three times the annuity's value, or $375,000. Covered benefits include nursing-home care, home health care, assisted living and adult day care.
If instead you decide to annuitize, your payments will be based on the $125,000 value; the cash-out value will be $125,000 as well. The insurer will ask you for medical information and could deny your application, but, says Veomett, it's a "simplified form" compared with requirements for long-term-care insurance.
Another twist on the fixed deferred annuity is Liberty Mutual's Freedom Series Builder Annuity. Mark McVeigh, senior vice-president of marketing and distribution, says the product is aimed at someone who needs to save for retirement but also "wants to protect against a series of health-related issues."
When you buy this annuity, you can choose from a menu of three "modules," including one for health care. You can withdraw the money at no charge before the end of the eight-year surrender period if you or your spouse require a stay in a medical facility, are diagnosed as terminally ill, or cannot perform two daily living activities, such as bathing or eating. If you reach the end of the surrender period before needing care, you can allow your investment to grow, turn it into a monthly income stream or cash out. The health module boosts the annuity's cost by 0.10%, McVeigh says.
Many hybrid products are complex and restrictive. You should review any purchase with a financial adviser who is not selling the product.
If you already have life insurance or an annuity, you may be able to tap the policy to pay for health care. Under a new law, current owners can exchange their policies for either a long-term-care policy or a hybrid policy without having to pay taxes. In the past, you first needed to cash out the annuity or life insurance policy and pay tax on the investment gains.
Also, most permanent life insurance policies will allow you to use the cash value or dividends to pay for any expenses, including health care. With many policies, you also can accelerate your death benefits if you are diagnosed with a terminal illness.