Under-estimating the Impact of Out-of-Pocket Medical Costs Could Threaten Your Comfortable Retirement

A new study shows that healthcare could cost retirees more than $200,000—even with Medicare coverage. Can you invest enough to make up for any shortfall?

Even with coverage from Medicare, Fidelity Consulting1 (a division of Fidelity Investments) projects that an American couple that retirees at age 65 will need about $200,000 to cover 20 years of out-of-pocket medical costs-excluding the cost of over-the-counter drugs, dental services, or long-term care. That's 5.3 percent more than last year's $190,000 figure, an increase that Fidelity says is due to healthcare costs rising 5.8 percent a year since it began releasing the estimate in 2002.

The estimate for healthcare costs assumes that retirees do not have employer-sponsored retiree health care, but includes 1) expenses associated with Medicare Part B and Part D premiums, 2) Medicare cost-sharing provisions (such as co-payments, co-insurance, deductibles, and excluded benefits), and 3) out-of-pocket costs for prescription drugs.

Think that seems like a lot? Fidelity's number actually may be low, according to the Employee Benefit Research Institute (EBRI). It says Fidelity’s study didn't account for future life expectancy, and estimates that a 65-year-old couple who retires without employer-sponsored health insurance will require $216,000 if they live to age 80, $444,000 if they live to age 90 and $778,000 if they live to age 100. "Medicare covers only 51 percent of expenses associated with health care services," writes EBRI in an issue brief. "Individuals are in large part responsible for covering the other 49 percent. Meanwhile, Medicare faces insolvency in 2018 and it is likely that benefits will be reduced in the future. Hence, if Medicare benefits are reduced, a couple age 65 today may need significantly more than $300,000 for healthcare expenses in retirement."

That may seems like a lot of money, but when you take the power of compounding into account, it may be easier than you think to save it. For illustrative purposes, let’s use Fidelity's assumption that a couple would need $200,000 to cover 20 years of medical expenses in retirement. That’s $10,000 a year. If you can afford to put $150,000 into a "medical expenses" account at retirement, which returns a hypothetical average annual return of 8%, you could withdraw $10,000 per year, and not run out of money for 20 years. In fact, you’d end up with $718,465. The table below illustrates.
Growth of $150,000 with $10,000-per-year withdrawals
Age Balance Withdrawal 8% Earnings
65 $150,000 $0 $12,000
66 $162,000 $10,000 $12,160
67 $174,160 $10,000 $13,133
68 $187,293 $10,000 $14,183
69 $201,476 $10,000 $15,318
70 $216,794 $10,000 $16,544
71 $233,338 $10,000 $17,867
72 $251,205 $10,000 $19,296
73 $270,501 $10,000 $20,840
74 $291,341 $10,000 $22,507
75 $313,849 $10,000 $24,308
76 $338,157 $10,000 $26,253
77 $364,409 $10,000 $28,353
78 $392,762 $10,000 $30,621
79 $423,383 $10,000 $33,071
80 $456,453 $10,000 $35,716
81 $492,170 $10,000 $38,574
82 $530,743 $10,000 $41,659
83 $572,403 $10,000 $44,992
84 $617,395 $10,000 $48,592
85 $665,987 $10,000 $52,479
86 $718,465
Source: Javelin Marketing. Assumes a starting balance of $150,000 is reduced by $10,000 each year, then multiplied by 0.08%. This example is hypothetical and for illustrative purposes only. It is not meant to represent performance of any particular product.