Your biggest retirement expense isn't housing, food, transportation, or taxes. It's very likely going to be healthcare. Even if you're in good health today, you'll spend thousands each year on Medicare premiums plus copayments and coinsurance. Here's a look at how you can use an aggressive growth fund like iShares Core S&P U.S. Growth ETF (IUSG -0.03%) to start planning for that expense now.
The cost of healthcare in retirement
Do some research on what retirees actually spend on healthcare, and you're likely to get a wide range of answers. One study from the Employee Benefit Research Institute estimates retired couples will need $270,000 cumulatively to cover their medical costs during retirement. Another report from HealthView Services pegs this lifetime cost for two retirees at $606,337. Still a different analysis from Fidelity estimates a single retiree will spend an average of $5,200 annually on healthcare.
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While the exact amount you'll need for healthcare expenses in retirement is hard to nail down, one thing is clear: You have to start planning now, and there are two big reasons why. The first is that it takes time to amass a six-figure savings balance. But your efforts to save enough will also be hindered by inflation. While the general inflation rate in the U.S. is fairly low, around 2%, healthcare inflation has been much higher. It's currently running at 4.2%. Assuming you plan to retire in 2045, 4.2% inflation nearly triples that $5,200 annual expense to about $14,500.
How much to save
The big question is: What kind of saving and investing program would it take to support $14,500 in annual out-of-pocket healthcare expenses starting 25 years from now, in 2045? That's a tricky question to answer. You could use the 4% rule to calculate a savings balance that would support annual withdrawals of $14,500, but that's likely not conservative enough. Unfortunately, the 4% rule becomes less reliable with sustained, high inflation rates. A safer bet is to assume that your $14,500 withdrawals will be no more than 3% of your savings balance. That equates to a target savings number of about $484,000.
Lean on your HSA
Ideally, you'd build that medical nest egg in an HSA. That allows you to withdraw the funds without tax implications as long as you're using them for your medical costs. HSAs also provide a wide range of investment options, including ETFs that are specifically positioned for growth. You'll need something moderately aggressive because your healthcare savings plan will be limited by HSA contribution caps.
Unfortunately, most people aren't eligible for an HSA because they don't have qualifying high-deductible health insurance coverage. If you do, though, it's smart to take advantage of it.
For an individual HSA, the contribution cap in 2021 is $3,600. That equates to monthly contributions of $300. To turn a $300 monthly deposit into $484,000 in 25 years, your investment would need to grow more than 11% annually after inflation -- a pretty aggressive hurdle. The good news is that contribution limits should increase over time. If you raise your contributions annually as the limit goes up, that'll ease the pressure on your required growth rate.
A growth ETF for long-term savings
Having said that, there are equity funds and ETFs out there that have historically delivered double-digit growth rates. While past performance isn't a guarantee of what will happen going forward, it can indicate whether the fund has delivered on its investment objective. One fund that's positioned for growth is the iShares Core S&P U.S. Growth ETF. The fund holds 527 positions in its portfolio, consisting of large- and mid-cap U.S. companies with growth characteristics. Net assets total $9.74 billion and the top four sectors represented are technology, consumer discretionary, communication, and healthcare.
Over the last 10 years, the iShares fund has produced pre-tax average annual returns of 15.92%. That includes 29% growth over the last 12 months. Also notable is the fund's ultra-low expense ratio of 0.04%.
While the iShares fund has impressive average returns, performance from one year to the next has varied widely. In 2013, for example, the fund grew nearly 34% -- but then it showed a 0.78% loss in 2018.
That's the nature of growth funds; they can be a rollercoaster ride. Keep that in mind as you decide how to use this position. It could be appropriate for a long-term savings goal, like saving for retirement healthcare costs that you'll incur 25 years from now. But if you need the money within the next 10 years, you might want something more stable.
An inexact science
Planning for your future healthcare expenses is not an exact science. Even so, it is safe to assume that your medical costs will probably be the largest line item on your retirement budget. And that means you're smart to save and invest as much as you can now in your HSA. You can always adjust your plan later, but you can't go back and make up for earnings missed because you didn't start saving soon enough.
