Could Your Retirement Plan Handle Higher Health Care Costs?
You may have a clear picture of what retirement will cost: housing, groceries, travel, and the activities you finally have time to enjoy. Health care can be harder to pin down.
Premiums can change. A new prescription can add an ongoing expense. An unexpected health issue can increase both medical bills and the need for help at home.
That uncertainty makes health care an important part of stress-testing your retirement plan.
The question is straightforward: If these expenses turn out to be higher than expected, what would need to change?
What Does It Mean to Stress-Test Your Plan?
A retirement plan uses assumptions about spending, investment returns, inflation, and how long your money needs to last. Stress-testing means changing some of those assumptions to see how your finances respond.
For health care, that could mean testing faster annual cost increases, a year with unusually high out-of-pocket expenses, or several years of paid care.
The goal is to identify where you have room to absorb additional costs and where an adjustment today could give you more flexibility later.
Start With the Full Cost of Coverage
Your monthly insurance premium is only one part of your health care budget. Depending on your coverage, you may also need to account for deductibles, copayments, coinsurance, prescriptions, and services your plan does not cover.
Medicare still involves premiums and other out-of-pocket costs. Original Medicare also has no annual out-of-pocket limit for Part A and Part B services without additional protection. Your choice of coverage affects how much of that exposure you retain.[1]
Build your estimate around your actual coverage and health needs. Include irregular expenses, such as dental work, that may be easy to overlook in a typical month. Medicare generally does not cover routine dental care, although certain dental services connected to covered medical treatment may qualify.[2]
If you plan to retire before becoming eligible for Medicare, estimate those years separately. If you and your spouse will transition to Medicare at different times, reflect both timelines in the plan.
Test What Faster Increases Would Mean
A single inflation assumption for your entire retirement budget can hide how sensitive the plan is to a particular expense.
Consider a hypothetical household spending $12,000 per year on health care today. After 15 annual increases:
At 3% per year, annual spending would reach approximately $18,700.
At 5% per year, annual spending would reach approximately $24,900.
At 7% per year, annual spending would reach approximately $33,100.
These are illustrations, not forecasts or estimates of what a typical household should spend. They assume the same starting budget and a constant increase each year, without a separate change in coverage or care needs.
At 5% rather than 3%, the household would need about $6,200 more in that fifteenth year alone. A useful stress test asks where that additional money would come from and whether the plan could support it over time.
Add a Separate Scenario for Long-Term Care
Gradual cost increases are only part of the picture. Needing ongoing help with bathing, dressing, or other daily activities can create a different category of expense.
Medicare generally does not pay for this type of custodial long-term care. Its coverage for qualifying skilled care is different from paying for ongoing personal assistance.[3]
A meaningful scenario should consider the type of care you would prefer, local costs, how long care might be needed, and any insurance benefits available. It should also account for expenses that continue for a spouse living at home.
Ask your advisor to show what happens if care is needed for several years. Which assets would fund it? How would it affect the other spouse’s income? Would your preferred arrangement remain affordable?
Look at Taxes and Timing, Too
The amount you need to withdraw may be greater than the bill itself. If a withdrawal is taxable, the plan needs to account for the associated tax cost.
Higher income can also increase Medicare Part B and Part D premiums through income-related surcharges, known as IRMAA. Social Security generally uses tax information from two years earlier to determine these charges.[4]
That makes the timing and source of withdrawals worth reviewing alongside health care spending. A larger distribution may have consequences beyond the current year.
It is also useful to test higher expenses during a period of weak investment returns. Paying an unexpected bill while your portfolio is down can place additional pressure on the plan.
Turn the Results Into Decisions
A stress test becomes useful when it helps answer practical questions:
How much additional annual spending could the plan absorb?
What money would be available for an unexpected expense?
Would higher costs require changes to travel, gifts, or other flexible spending?
Would saving more, adjusting retirement timing, or reviewing insurance improve the outlook?
How would an extended care need affect a spouse’s financial security?
You may find that your plan already has sufficient room. Or you may identify a manageable adjustment that makes a meaningful difference.
Health care assumptions deserve a fresh look as coverage, prescriptions, and family circumstances change. Revisiting them regularly helps keep the plan connected to your life.
If you are approaching retirement or already retired, consider making health care a focus of your next planning conversation. Our team can help you evaluate how higher costs could affect your retirement income and explore adjustments that fit your goals.
Sources
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through TOP Private Wealth, a registered investment advisor and separate entity from LPL Financial
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