Avoiding the Sinkhole of Medical Expenses In Retirement

Flickr / Nina Matthews.

Health care expenses for retirees are high and growing. And while a recent paper published in the American Journal of Law and Medicine found that we're pretty good at understanding the basic costs of medical expenses, it turns out that at the same time we're deeply in the dark when it comes to understanding the risk these expenditures pose to our way-of-life in retirement. 

The alphabet soup of medical coverage in retirement 
There are a lot of options for retirees. Medicare, Medicaid, supplementary coverage through private insurance companies or an employer -- the list is complex and seemingly endless.

Sifting through these options is one thing; figuring out how much it's all going to cost at the end of the day, between premiums, deductibles, and other expenses, is quite another. 

So how much is health care in retirement going to cost you?

Well, the answer is, of course, that it depends on your health, on your lifespan, and on your willingness and ability to pay. Outside of the personal questions, it also depends on things completely beyond your control, like overall medical costs and government policies. 

However, much research time has been devoted to the subject of how much you're likely to spend. One study, which attempts to project expenses out into the future (and which is aptly named "Will Healthcare costs Bankrupt Aging Baby Boomers?"), finds a disturbing inflationary trend: 

Another, conducted by the Employee Benefit Research Institute, looks at lifetime spending for men and women retiring at different points, with similar inflationary results:

(You might be wondering why women spend more. Studies have found they're less likely to have supplemental employer coverage, which means more costly Medigap coverage. These differences are reduced when you go to higher spending percentiles -- in other words, the sicker the person or more costly the care, the less difference it makes if you're male or female.)

These numbers tell us that healthcare costs are pretty high, and rising. And the authors of this paper found that people were actually pretty good at estimating the component costs of coverage and what they would need, more or less, to meet them. Good news, right? Well, on the surface yes, but there was one major problem.

"Some people know costs; few know risks"
Unfortunately, having a sense of basic costs is actually of little use when it comes to specific situations. What many people failed to take into account in the survey, and what we probably collectively fail to take into account in the real world, is the immense uncertainty we face when it comes to our own health care expenses -- both as a matter of individual health and as a matter of changes outside our control.

At the end of the day, you might spend far less on health care than the average retiree ... or you might spend far more. To give you an example, let's a look at the extended version of the annual expenditures chart above for the years 2010 and 2040. 

You can see that costs in 2040 are projected to be about 140% of costs today for all spending levels. But did you notice the extreme variation in those levels within the same year? For both, there is a difference of about 200% between spending at the 25th percentile and spending at the 90th. 

That difference amounts to over $9,000 per year in 2040. 

The enormous cost of uncertainty
These results illustrate how much costs can vary from one person to another. Couple the table with some choice statistics about Medicare -- "The top 5% of Medicare beneficiaries account for 43% of total spending, and the top 25% account for 85% of spending" -- and you begin to appreciate that costs can skyrocket more than you might have imagined.  

Maybe we'll all get lucky, but we simply don't know what's going to happen over a 30 year retirement, whether it's an accident, sudden illness, or just severely declining health.

That might sound incredibly morbid, but it certainly should make you think. Maybe, instead of thinking we're just about average (or excellent) in terms of health, we need to plan for those worst-case scenarios. The costs of not doing so could be steep.