Sunday, October 28, 2012

A Moving Target

Trying to figure out how much money an individual or couple needs to live on in retirement is, to put it mildly, a complicated business. Among other factors, it depends on the age at which he or she retires, where they live, and how they live. It can be affected by marital status, their health, and the markets, both before and after retirement.

And, as a recent EBRI Notes article (see “Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News”) explains, it can also be affected by the availability and source of health insurance coverage after retirement to supplement Medicare, and the rate at which health care costs increase.

Additionally, public policy that changes any of the above factors will also affect spending on health care in retirement. Consequently, trying to hit that target can feel like aiming at a bulls-eye that is not only moving, but moving fast, and zig-zagging away from the bouncing, moving vehicle in which you find yourself.

We’re often asked to come up with a single number that individuals can use to set their retirement savings goals—and while it’s certainly possible to do so (and others have), what’s often glossed over is that while that approach appears to offer clarity, a single number based on averages will be wrong for the vast majority of the population.¹ Moreover, frequently overlooked in the generalizations about retirement spending levels is the very real (and potentially huge) financial impact of post-retirement health care expenses.

Individuals will be responsible for saving for health insurance premiums and out-of-pocket expenses in retirement for a number of reasons. Medicare generally covers only about 60 percent of the cost of health care services for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounts for 13 percent. The percentage of employers offering retiree health benefits has been falling, even in the public sector, and even when offered, those benefits are becoming less generous and more expensive to the retiree.

Using a simulation model, we recently estimated the amount of savings needed to cover health insurance premiums and out-of-pocket health care expenses (excluding long-term care) in retirement. The EBRI article presents estimates for people who supplement Medicare with a combination of individual health insurance through Plan F Medigap coverage and Medicare Part D for outpatient-prescription-drug coverage. For each source of supplemental coverage, the model simulates 100,000 observations to allow for the uncertainty related to individual mortality and rates of return on assets in retirement, and computes the present value of the savings needed to cover health insurance premiums and out-of-pocket expenses in retirement at age 65. From those observations, the analysis determined asset targets for having adequate savings to cover retiree health costs 50 percent, 75 percent, and 90 percent of the time, both for individuals,² and for a stylized couple, both of whom are assumed to retire simultaneously at age 65.³

Of course, some will need more money than the amounts cited in the report, which did not factor in the savings needed to cover long-term care expenses, nor the reality that many individuals retire prior to becoming eligible for Medicare. Some will need to save less than projected if they choose to work during retirement.

Still, as hard as it can be to hit a moving target, it’s even harder to hit a target you can’t see.

- Nevin E. Adams, JD

¹ For more on the shortcomings of this approach, see “Single Best Answer.”

² Separate estimates are presented for men, women, and married couples. Because women have longer life expectancies than men, women will generally have larger expenses than men to cover health insurance premiums and health care expenses in retirement, regardless of the savings target.

³ Our analysis found a 1–2 percent reduction in needed savings among individuals with median drug use and 4-5 percent reductions in needed savings among individuals at the 90th percentile in drug use since EBRI’s 2011 analysis (see “Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News”).

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