William Lako: Plan for health care costs to protect retirement savings

According to the Employee Benefit Research Institute, couples 65 and older will likely need between $212,000 and $383,000 to cover their health care costs in retirement. There are many variables to that amount, including available insurance plans, high prescription drug expenditures, and life expectancy. So how do investors even begin to plan for health care costs? Earmarking nearly $400,000 right out of the gate is a little extreme, if not nearly impossible, for most.

First, realize that retirement can last 20 to 30 years, so most investors are looking at roughly $11,900 a year for health care costs, including premiums, prescription drugs, and out-of-pocket costs. However, these figures do not factor in long-term care costs, which could be as high as $100,000 a year.

When retirement is about 10 years away, investors generally start paying attention to their investments and financial plan, as these are the years they can save aggressively with catch-up contributions. When investors are developing their cash flow projections for those first few years of retirement, they should account for all spending needs, including health care costs. Consider what the maximum spending could be, assuming assets will last until age 92 for the youngest spouse. I generally recommend investors use less than 85 percent of their maximum spending. This difference between annual spending and maximum spending helps retirees absorb an unexpected health care expense.

According to the U.S. Department of Health and Human Services, about 70 percent of people over age 65 will need long-term care services at some point in their lives. Long-term care insurance can help cover the costs of services, such as nursing home care, assisted living, and home health care. For investors in their early 50s, premiums for long-term care insurance can be very affordable; however, at age 55, one could expect a 10 percent to 15 percent increase, and by age 60, one might see a 28 percent to 32 percent increase. Having these policies in place can make a significant impact on cash flow.

Another way to manage health care costs in retirement is by using a Health Savings Account (HSA). An HSA is a tax-advantaged savings account used to pay for medical expenses. While working and participating in a high-deductible health plan, the investor can contribute to an HSA, which can also be invested similarly to a 401(k). This potential growth can also provide a substantial source of funds for health care expenses, as HSA funds stay with the investor after they retire. Any earnings or withdrawals used for qualified medical expenses are tax-free.

Seniors also need to understand what benefits they will receive through Medicare, the federal health insurance program for people 65 or older. While Medicare can help cover some health care costs in retirement, it does not cover everything. For example, Medicare does not cover long-term care services or most dental, vision, and hearing services. As a result, many people choose to purchase supplemental insurance policies, also known as Medigap policies, to help cover these additional costs.

Individuals can better protect their overall retirement savings by taking a comprehensive approach to health care budgeting in retirement planning.