Underestimating Retirement Medical by a Factor of Four

Americans drastically underestimate how much money they'll spend on medical care in retirement.

Imagine booking a nice vacation for two and projecting that your total cost would end up being $4,000. And when you received the final bill, after someone applied smelling salts to revive you, you looked at the itemized bill a second time and saw a figure exceeding $15,000.

That's a shock. As disheartening as the bill is, however, it's probably not insurmountable. Perhaps you can pay it off in small increments over time. Maybe you can work more hours or secure a second job to earn enough extra money to retire the debt. Or perhaps you can cut back on some other expense - like the next two years' vacations - to dig out from the unexpectedly high expense.

But there is a time in your life when you may not have those options at your disposal if you fall substantially short in estimating an expense. That time is retirement, and that cost is medical coverage and care.

Defining Medical Expenses in Retirement

Let's set the stage by defining categories of medical expenses in retirement.

Cost of Coverage. Most Americans prepay their Medicare Part A (inpatient, hospice, and home-health care) premiums through payroll taxes that are deducted from their paychecks for at least 40 quarters (10 years) of work. But Medicare B, which covers outpatient services, charges a premium of at least $174.70 monthly in 2024 (greater with higher incomes). Medicare Part D (prescription-drug coverage) plans, which are sold and priced by private companies, typically cost $50 or more monthly. In addition, enrollees who choose traditional Medicare (versus Medicare Advantage, a managed-care option) must purchase a Medicare supplement plan at a monthly premium of $200 or more to protect themselves against uncapped Part B coinsurance.

Coverage can easily cost between $2,000 (Medicare Advantage) and $5,400 (Part B, Part D, and a Medicare Supplement plan) annually. Multiply those figures by 18 years of retirement and the figures approach $36,000 and $100,000 - in 2024 dollars. Factor in inflation at 3% and the cost of coverage is $47,000 for Medicare Advantage and more than $126,000 for traditional Medicare with prescription-drug coverage and a supplement plan.

Cost of Care. Part A imposes a deductible of $1,632 for each hospitalization. Patients who remain in the hospital after 60 days also pay a daily copay of $408 or $816. Part B services are subject to a $240 deductible, then 20% coinsurance with no annual or lifetime cap. Part D imposes deductibles, coinsurance, and copays that can cost thousands of dollars annually.

And then there are costs that Medicare doesn't cover. Your eyes and teeth aren't getting any younger as you age. You may be more reliant on over-the-counter drugs and medicine to manage arthritis pain, sleep disorders, and digestive issues. These services and items aren't covered by any Part of Medicare.

How Much the Average Retiree Expects to Pay

Fidelity conducts a comprehensive study of retirement medical costs annually. The 2023 report shows that, on average, survey participants projected that a couple would spend $41,000 on medical expenses in retirement.

What the Average Retiree Actually Pays

Fidelity's report shows that a retiree living an average lifespan will spend about $157,000 on medical coverage (premiums) and care (out-of-pocket financial responsibility). That's an increase from the $80,000 that Fidelity reported in 2002 - and that figure is twice the 2023 respondents' projection.

The $157,000 figure works out to about $9,000 annually, assuming a lifespan of 18 to 20 years after turning age 65. Young, healthy seniors can expect to pay less per year, whereas those nearing the end of life are more likely to pay much more than the average.

Paying for Coverage and Care in Retirement

So, how does the average retiree pay for $157,000 of medical expenses in retirement (or the average couple pay $315,000)?

Here are the two most common options:

Social Security. The average Social Security check in 2024 is about $23,000. Thus, medical expenses would consume about one-third of their benefit, leaving about $16,000 annually (or $1,300 monthly) for housing, food, transportation, clothing, travel and entertainment, and other expenses. But there's a catch. Most retirees with another stream of income - even a modest one - pay taxes on between 50% and 85% of their benefit, thus reducing the spending power of their monthly benefit.

Pensions and retirement savings. Retirees who have earned pensions or accumulated retirement savings have an additional source to reimburse the cost of medical coverage and care. These sources of income are taxed, which means that a retiree would have to earn or withdraw between $1,850 (12% federal marginal tax rate) and $2,100 (22% rate) to pay for a single $1,632 inpatient deductible. If the retiree lives in a state that imposes a 5% state income taxes, the figures rise to about $1,970 and $2,250.

The Health Savings Account Advantage

There is a third source of funds to pay for medical coverage and care in retirement. It requires both knowledge and time. Fortunately, more Americans every year understand the power of this strategy.

The third source is a Health Savings Account. Owners fund their accounts with pre-tax or tax-deductible contributions, which allows the full contribution to pass into the account to frow. Balances grow tax-free. And withdrawals for qualified medical expenses - including all Medicare premiums and out-of-pocket costs, plus qualified expenses not covered by Medicare - are tax-free.

Thus, a retiree paying that $1,632 inpatient charge would withdraw $1,632 from a Health Savings Account, not an amount between $1,850 and $2,250 from a tax-deferred retirement plan, to settle the bill. Those differences add up quickly. The average retiree can reimburse the $315,000 of projected medical spending by withdrawing $315,000 from a Health Savings Account, rather than a figure between $358,000 and $404,000 (or between $384,000 and $431,000 with a 5% state income tax) from a tax-deferred retirement account.

That's a difference of $43,000 or more, up to more than $100,000. Let's assume a mid-point of $60,000 in tax savings by reimbursing these expenses from a Health Savings Account rather than a tax-deferred retirement account. That's about an extra $3,300 annually in spending power (or, alternatively, $60,000 to pass to your heirs). Imagine the power of an extra $275 in your monthly budget when you're living on a fixed income. Does that amount represent dues to a local golf course? Weekly date nights at a restaurant? Your electric bill? Your grocery bill?

The Bottom Line

Too many Americans dramatically underestimate the amount that they'll spend for medical coverage and care in retirement. These expenses are real, largely unavoidable, and sneak up on seniors as lower costs in retirement (when health is generally better) morph into much larger costs in later years. Consistently funding a Health Savings Account and retaining and investing those balances over decades doesn't make these expenses go away. But those funds buy a lot more coverage and care than income derived from taxable Social Security checks and taxable withdrawals from tax-deferred retirement accounts.

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HSA Wednesday Wisdom is published every other week, alternating with HSA Question of the Week. The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.