Sunday, November 25, 2012


Retirement planning is a complex and highly individualized process, but many people find it easier to start by focusing on a single, specific target number.

For those interested in a single number for health care expenses in retirement, a recent EBRI report provides that. Among other things, the report noted that a 65-year-old man would need $70,000 in savings and a woman would need $93,000 in 2012 if each had a goal of having a 50 percent chance of having enough money saved to cover their projected health care expenses in retirement. A 65-year-old couple, both with median drug expenses, would need $163,000 in 2012 to have a 50 percent chance of having enough money to cover health care expenses.1

Determining how much money is needed to cover health care expenses in retirement is complicated. It depends on retirement age, the length of life after retirement, the availability and source of health insurance coverage after retirement to supplement Medicare, the rate at which health care costs increase, interest rates, market returns, and health status, among other things. That said, it is possible to project health care expenses with some accuracy, and EBRI’s recent analysis uses a Monte Carlo simulation model to estimate the amount of savings needed to cover health insurance premiums and out-of-pocket health care expenses in retirement.

However, those recent “single number” projections specifically excluded the financial impact of long-term care.

EBRI has long acknowledged the critical impact that health care expenses can have on retirement finances, and considering that EBRI has long incorporated both the costs of health care and long-term care in its Retirement Savings Projection Model® (RSPM), one might well wonder why this particular report specifically excluded those long-term care projections.

For all the complexity in those calculations, the reality is that everyone won’t have to deal with the expenses associated with long-term care. For those who will, the impact on retirement finances could be significant, even catastrophic.2 That’s why EBRI has modeled their impact in the RSPM since 2003.

As noted above, for those interested in a single number, the recent EBRI report provides that, along with variations that permit one to take into account different likelihoods of success and gender/marital combinations. We are able to do that because we treat longevity risk and investment risk stochastically,3 and the fact that those expenses (and the costs of insurance) are, at least relatively, predictable.

But while it is possible to come up with a single number that individuals can use to start setting retirement-savings goals, it is important to bear in mind that a single number based on averages will be wrong for the vast majority of the population—and that those who rely exclusively on that single number run the risk of running short.

Nevin E. Adams, JD

1 Unlike reports produced by a number of organizations, the EBRI report also provided estimates for those interested in a better-than-50-percent chance of success. See ”Savings Needed for Health Expenses for People Eligible for Medicare: Some Rare Good News,” online here.

2 The EBRI Notes article above illustrates the difference: If you ignore the impact of nursing home and home health care expenses, more than 90 percent of single male Gen Xers were projected to have no financial shortfall in retirement—but when that impact was included, just 68 percent of that group was projected to have no financial shortfall in retirement. The error of ignoring nursing home and home health care costs is even more profound if one focuses on the percentage of individuals with shortfalls in excess of $100,000.

3 For an expanded description of the difference stochastic modeling can make, see “Single Best Answer.”
See also: “Employment-Based Retiree Health Benefits: Trends in Access and Coverage, 1997-2010”, and “Effects of Nursing Home Stays on Household Portfolios.”

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