Many Americans don't have a clue about health care costs in retirement

Americans are vastly underestimating the amount of money they need in retirement for healthcare costs.

The average estimate from folks in a recent Fidelity survey was just $41,000. In fact, Americans will spend nearly eight times that amount in their golden years, according to the new Fidelity Retiree Health Care Cost Estimate, which forecast a retired opposite sex couple age 65 in 2022 may need an average of $315,000 saved (after tax) to cover health care expenses in retirement.

Fidelity’s estimate is up 5% from 2021 ($300,000) and has nearly doubled from its original $160,000 in 2002. The 2022 estimate for single retirees is $150,000 for men and $165,000 for women.

“Our research indicates a persistent lack of understanding around what people need to do to save for health care costs in retirement and just how much they’ll need to have saved,” Hope Manion, senior vice president at Fidelity Workplace Consulting, told Yahoo Money.

“Too often conversations about retirement focus on the fun parts, like where you’ll live or travel, or the extra time with family and friends, but it’s important to consider how you’ll pay for not only those happier moments, but also the inevitable costs of health care in retirement.”

What does the $315,000 include?

About 15% of the average retiree’s annual expenses will be used for health care-related expenses, including Medicare premiums and out-of-pocket expenses.

Obviously, that figure comes with caveats because ultimately what a retiree will spend depends on when he or she retires and where they live, their overall health, and that great mystery of how long they will live.

Fidelity’s estimate assumes both members of the couple are enrolled in traditional Medicare, which between Medicare Part A and Part B covers expenses such as hospital stays, doctor visits and services, physical therapy, lab tests and more, and in Medicare Part D, which covers prescription drugs.

The calculation takes into account monthly premiums, standard Medicare cost-sharing provisions, expenses that aren’t covered by Medicare like vision or hearing aids, as well as prescription drug out-of-pocket costs.

It does not include other health-related expenses, such as over-the-counter medications, most dental services, and long-term care.

What's driving the increase in health care costs?

Soaring health care inflation is driving the upsurge in expected costs. Even if health care inflation rates remain at this level for a short period, inflation compounded over time will drive retiree costs significantly higher, according to Healthview Services’s “Health care Costs Data Report Brief: The Long-Term Impact of Short-Term Inflation 2022.”

A healthy 65-year-old couple retiring today entering Medicare will need 71% of their lifetime Social Security benefits to cover their medical expenses - 9% more than if inflation had remained at historic levels, according to that analysis. For those retiring in 20 years, health expenditures will exceed projected Social Security income by 56%.

Another factor in the uptick in Fidelity’s estimate is the jump in Medicare B premiums this year. The 2022 monthly Part B premium rose by $21.60, or nearly 15 percent, to $170.10 from $148.50 in 2021.

The culprit: Aduhelm, the controversial drug approved last year by the U.S. Food and Drug Administration for the treatment of Alzheimer's disease. Medicare usually covers FDA-approved drugs, but this one comes with a shocking price set by its maker, Biogen —$56,000 per patient annually. The drug will be covered under Part B, rather than the Part D prescription drug program.

About half of the increase in the premiums has been attributed to the drug.

On May 27, the Centers for Medicare & Medicaid Services (CMS) said it would not change Part B premiums this year. A lower 2023 premium is under consideration.

How to plan for health care costs in retirement

“The Fidelity number is scary,” Philip Moeller, a Medicare and Social Security expert and principal author of the “Get What’s Yours” series of books about Social Security, Medicare, and health care, told Yahoo Money. “But lower-income people have Medicaid and don’t pay these big bills. Further, most health spending occurs in later life.”

In other words, you might not reach the age when those bigger bills land.

A recent blog post by Moeller explored the rising costs. “Medicare, however, can be an excellent insurance program,” Moeller said. “Free Medicare help is available from the State Health Insurance Assistance Program (SHIP); counselors also can explain the substantial medical assistance programs Medicare provides.”

But it’s important to note that even on Medicare, you’re still going to be on the hook for some number of bills.

“Even once you reach Medicare eligibility at 65, there are still hefty costs,” Manion said.

To fill the gaps, folks need to plan.

Those surveyed by Fidelity who feel prepared for the cost of health care in retirement ramps up when the person has a health savings account (HSA), a tax-advantaged account designed to help cover out-of-pocket health care expenses.

Nearly half (47%) of HSA holders feel prepared for their health care retirement expenses, compared to just 27% of people who do not have an HSAs, according to Fidelity.

More than 80% of large employers currently offer an HSA to their employees, according to a survey by benefits consultant Willis Towers Watson, while only 4% of companies offer health benefits to retirees, according to the Employee Benefit Research Institute (EBRI).

But not everyone is eligible to contribute to an HSA.

In order to participate, your health insurance plan must offer a high-deductible plan. You can also open an account as a self-employed freelancer or business owner if you have a qualified high-deductible health plan (HDHP).

For 2022, the IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP’s total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can’t be more than $7,050 for an individual or $14,100 for a family. (This limit doesn't apply to out-of-network services.)

In 2022, you can contribute up to $3,650 if you have individual health insurance or up to $7,300 for family coverage. If you’ll be 55 or older at the end of the year, you can set aside an extra $1,000 in “catch up” contributions. Those limits will increase around 5% for 2023 due to the spike in inflation, the IRS recently announced.

In addition to saving pretax dollars (and potentially adding employer contributions), and investing the savings, the funds are withdrawn tax-free for federal and, generally, state tax purposes, if used for qualified medical expenses. And unlike flexible spending accounts, contributions do not need to be used annually, but rollover year after year. The HSA can be used for unexpected expenses that Medicare doesn’t pay – such as dental and vision care.

HSAs can also help cover the cost of travel such as an air or train fare or gasoline for essential medical care if you need to travel out of your state for a medical procedure. And even if your spouse or children are not covered under your medical plan, they can also tap your HSA.

“Save all your receipts for health expenses through the years as those expenses can be withdrawn from the HSA anytime tax free,” Dr. Carolyn McClanahan, a financial advisor for Life Planning Partners and a physician, told Yahoo Money. “They don’t have to be withdrawn in the year you incur the expenses. If you don’t use the HSA for health care expenses, after age 65, you can use it for retirement but you have to pay taxes on the withdrawals.”

In addition to funding retirement savings, HSA balances, and personal savings, also focus on your health now to save for the future, Moeller said.

“Remember: The cheapest health care is the care you don’t need,” Moeller said. “That means diet and exercise, and the sooner you start, the better.”

Kerry is a Senior Columnist and Senior Reporter at Yahoo Money. Follow her on Twitter @kerryhannon

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