The Critical but Overlooked Factor in an Early Retirement

When considering retirement, the most generally accepted age people target is the magical age of 65.  However, we meet with a fair amount of folks who, due to their successful saving & spending habits (and prudent financial advice!), are on track to retire well in advance of this age.

In almost every case, these meetings are a pleasure as we get to talk about just how much they can spend on the grandkids’ education, world travel or that vacation home in the South.  But as their advisors, we also must ensure we temper these spending dreams by including a critical but often overlooked drain on cash flow that usually isn’t top-of-mind while employed- the costs of health insurance.  Importantly, these are costs both before Medicare kicks in and even after Medicare coverage applies, (typically at age 65) as these costs can be significant.

In a recent report from HealthView Services (which we discuss below), these costs can be substantial and must be considered when putting together the cash flow projections for those “golden years”.  While there is no perfect predictor of these actual costs, we think it is critical to factor in conservative estimates for this essential need.  This helps provide our clients a realistic view of how the cash will flow in retirement so as to ensure peace of mind and a truly comfortable and confident retirement.




Pre-Medicare Costs

As anyone who is not on an employer supplemented health plan knows, health insurance premiums are expensive and continue to rise.  While the pre-65 years are typically lower risk in terms of health expenses, everyone’s health situation is unique and must be considered.  So when we have a retiree targeting retirement at age 55 for example, we typically start by factoring in about $1,000 / month (as a minimum) for health insurance premiums until they reach Medicare eligibility.  Keep in mind, even with this level of premium there are other costs to consider as the price implies a high-deductible plan that will need ample cash reserves to cover what could be a $10,000 deductible per year.  In addition, we also apply a higher-than-inflation annual increase in premiums of about 4-5% per year.

Post-Medicare Costs

In their recent report titled “Retirement Health Care Data Report”, HealthView Services (a health care cost software provider) also pointed out that just because a retiree is covered by Medicare they are by no means in the clear for medical expenses.  They estimate that the typical 65 year old couple retiring this year will incur over $400,000 of out-of-pocket medical expenses (that would be NOT covered by Medicare) over their lifetime.  The reason?  Costs include Medicare Part B and Part D premiums, supplemental Medigap insurance, hearing, dental, vision costs and co-pays.

Looking forward, HealthView projects health care expenses could average an increase of over 5% per year, which would likely far outpace any Social Security and/or pension inflation adjustments (if any) that retirees may rely on to meet fixed costs.  This would assuredly put the squeeze on those travel and vacation home plans if not properly accounted for.

What to Do Now

For those not already in retirement, this is certainly the time to start factoring in these costs as a very real cash flow concern whether you plan on retiring at 50 or 75.   So what to do?

  • Increase 401(k) and any other retirement savings plans: Obviously, investing as much as possible prior to retirement allows for at least some measure of growth in order to help fund health care. Bumping up payroll withholding a little more now can be a lot less painful than writing big checks in retirement.
  • If available, max out annual HSA contributions: As discussed in our blog from October 2014 (click here to read) we are big proponents of Health Care Savings accounts.  These are essentially tax-deferred “Healthcare IRAs” and allow participants on a high deductible health care plan to save up to $7,750 (family plan with catch-up contributions) for future health care expenses in an account owned by the contributor, not the employer.
  • Be realistic: When taking a hard look at living expenses and cash flow in retirement, we believe it is critical to include a conservative estimate for what could be a significant expense for retirees.  So whether you work with an advisor or not, it is imperative any retirement cash flow projection includes both the pre-Medicare and post-Medicare costs.

Taking all this in to consideration, some folks may conclude they should actually wait a year or two to retire in order to save more and allow their investments to grow.   While working a little longer may be disappointing, it is much preferred to getting that gold watch at the retirement party, then getting that first premium bill in the mail and realizing the cash flow is unsustainable and retirement is now more stressful than the career!

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