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48% of Retirees Aren't Tracking This Major Retirement Expense

By Catherine Brock – Nov 8, 2020 at 12:50PM

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Overlooking this area of your budget leaves you vulnerable to the worst of financial surprises.

According to a recent study from insurance company Allianz Life, nearly half of retirees aren't tracking what they spend on healthcare. Given that healthcare stands to be a retiree's largest expense, flying blind in this area of one's budget could be a disastrous move.

Head off a financial crash-and-burn with a reality check on how much you could end up spending on healthcare, why you should be monitoring that spending, and strategies you can take before and during retirement to manage this major expense.

Senior couple looking at laptop on top of a white table.

Image source: Getty Images.

What healthcare could cost you

A paper from the Center for Retirement Research at Boston College pegged retirees' actual healthcare spending in 2017 at $4,300 monthly. That's $51,600 per year and nearly three times the average retiree's Social Security income.

Even more shocking are recent projections of the average cumulative healthcare costs retirees will absorb over the course of retirement. A 2019 HealthView Services report estimates that a 65-year-old couple will spend more than $600,000 in total on out-of-pocket medical costs. A 2020 analysis from Fidelity offers a slightly more palatable estimate of $295,000 in cumulative healthcare expenses for 65-year-old couples who retire this year. 

Why track your healthcare spending

High healthcare expenses pose a double threat to your finances. The first threat is obvious -- healthcare expenses can be high enough to consume a giant chunk of your income. The second threat is their rate of growth. Healthcare expenses have very high rates of inflation, averaging 4.9% per year, according to HealthView Services. That means if you spend $50,000 this year on medical costs, those expenses could easily tick up to $52,450 next year -- with no change at all in your health. After 10 years, a 4.9% inflation rate would raise that $50,000 total to more than $80,000.

For some perspective, the 2021 Social Security cost-of-living adjustment is 1.3%, well short of the healthcare inflation rate. If your healthcare costs rise nearly 5% annually and you don't trim spending in other areas or find another source of income, you likely have to increase your retirement savings distributions to keep up. And that could lower your earnings power and put your future solvency at risk. 

Monitoring your healthcare spending now won't lower your costs, but it does tell you where you stand. And that's a critical piece of information. If there's financial trouble ahead, you're better off knowing about it now so you can take action.

Manage costs three ways

Possibly the most effective strategy for controlling healthcare costs is committing to a healthy lifestyle. You already know the basics here. Get regular exercise, eat a balanced diet, and avoid health-sapping habits like smoking and excessive drinking. Plan on asking your physician for more detailed and personalized recommendations.  

Secondly, shop around for healthcare plans that pay for more of the services you need. Traditional Medicare doesn't cover dental, vision, or hearing services, for example, but some Medicare Advantage plans do. Also, consider your prescription drug needs and whether these are better served with traditional Medicare and a Part D plan or Medicare Advantage.

Plan on taking the medical expense tax deduction as well. Unreimbursed medical expenses, including premiums, that exceed 7.5% of your adjusted gross income in 2020 are tax-deductible. In 2021, those expenses must be greater than 10% of your adjusted gross income. You do have to itemize to get these deductions. But once you are tracking your healthcare expenses closely, the process of adding them up and documenting them for your tax return should be straightforward.

Future retirees: Save in an HSA

Saving in a Health Savings Account or HSA is another powerful strategy for managing your retirement healthcare expenses. There's a catch, though. You're only eligible to contribute to an HSA if you're not yet enrolled in Medicare and you currently have a high-deductible health plan. Meet those requirements and an HSA can save you thousands in tax dollars over the course of your retirement.

Here's how the HSA works: Funds you contribute to an HSA are tax-deductible. As with the money in your IRA, you can invest it and your earnings are tax-deferred. You can also take tax-free withdrawals at any time as long as you use the money to pay for healthcare -- a potentially lucrative perk you won't get from your 401(k) or IRA. Withdrawals for nonmedical purposes are subject to regular income tax plus a 20% tax penalty until you turn 65. After 65, the penalty drops away and you only pay income tax on the nonmedical distributions, just like you would in your 401(k).

It's not too late

It's never too late or too early to plan for your healthcare costs in retirement. If you still work and are eligible for an HSA, contribute whatever you can to that account today.

If you're already retired, start monitoring your current spending on healthcare premiums and other out-of-pocket medical costs. Then, consider how those expenses might evolve over time and whether you need to trim other areas of spending or find another source of income to provide a financial cushion. In the meantime, get some healthy living advice from your physician, shop around for more suitable coverage, and take your medical expense tax deductions.

And, yes, all of this is more work than flying blind -- but given what healthcare expenses can cost you in retirement, there's enough upside to justify your efforts.

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