By Allyn Hughes, CFP®, ChFC®, CLU®, ChFC®
We begin new client relationships with a comprehensive financial plan before we move on to investment strategy. The financial plan helps us understand the client’s current financial situation and expectations for the future.
Our discovery process includes a client profile document to identify the various pieces of someone’s financial life and also to understand their expected future spending.
A typical client’s retirement expense goals might look like this:
- Annual essential needs spending – $90,000
- Periodic home maintenance – $8,000 every other year
- Car replacement – $30,000 every five years
- Support for grandchildren – $10,000 per year
- Travel – $12,500 per year
One of the largest wild cards in long-term financial security is missing, or at least buried within the annual spending goal.
People rarely think about health insurance and out-of-pocket medical costs as a goal they should be sure to earmark assets or future income for.
According to Money Guide Pro, the financial planning program we use, the average retired couple should expect to spend over $300,000 during retirement on health insurance and related expenses. This number has a higher rate of annual increase than does the general cost of living – generally above 6%. So if you are age 50 and you plan to retire at 65, your medical care costs could be over $600,000 per couple, assuming average life expectancy.
Of course, most of us have no idea whether and how our medical costs will be spent. For many years in retirement your medical costs could be very modest—hardly something to plan for.
An analysis by the Kaiser Family Foundation found that Medicare spending—which is the primary payer for most retirees—rises consistently during retirement from an annual rate of ~$7,500 at age 70 to ~$16,200 at age 96. This amount does not include any Medicaid costs which often occur when the retiree has to go into a nursing home and does not have the resources to pay for it.
We think that an expected expense of at least $7,500 per year per person (growing at 6% annually) during retirement is a prudent starting point. If this amount is unspent one year, it should be accrued for the next year so you build a funding mechanism to pay for the high-expense years.
The reason to separate the $7,500 per year for health care from the overall $90,000 spending goal is primarily the different inflation factor assigned to each. Our default cost of living adjustment for regular spending is only 2.25% per year. Since health care costs grow at a faster rate, the amount allocated for health care within the overall spending goal would fall behind expected growth in costs over time.
So if you are thinking about how you will live and spend in retirement, make sure to create a goal for health care costs.
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