The elephant in the room of retirement planning

-- | 29/11/2018 Text size Decrease

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Healthcare costs are one of the biggest line items in most retiree budgets. Joining me to discuss some new Vanguard research on the topic is Jean Young, she's a senior research associate with the Vanguard Center for Investor Research. Jean, thank you so much for being here. Jean Young: Thank you for having me. Benz: Jean, let's talk about healthcare expenses in retirement, generally speaking. What are the big out-of-pocket costs that tend to occur in retirement? Young: I think the biggest cost retirees are going to face is the cost of their insurance premiums. They need to make a choice around supplemental insurance. But that’s probably the number one line item that people have to be prepared for. As we think about it--and this was a collaboration across divisions at Vanguard, we had folks from our advisory services group; we had folks from our investment strategy and our enterprise advice group as we started to think about this--and we actually did something that is unique for us a little bit. We decided to partner with Mercer, because while we are investment experts and planning experts and retirement experts, healthcare experts we could become. But we felt it would be better to partner with healthcare experts. So, our co-authors on this paper are two healthcare actuaries from Mercer. When we went into this we were very interested in the idea that there are all these big scary numbers out there. We don't think they are helpful. We went away from big scary numbers around saving for retirement. People think in terms of annual costs. Big scary numbers are actually behaviorally distracting and not actionable. Our view is you should think about your regular healthcare as an annual expense and we're all--you and I both-ave health care expenses today. As we think about it, we need to think about how much will that expense grow at retirement, and then of course you do need to think about how much it will grow over time. Because healthcare in the U.S, the costs for healthcare have been rising faster than inflation for a while. The trend is projected to continue. The number one expense people will face, most people will face, all people will face will be their insurance premium. Benz: And one point your colleague Maria Bruno has made that I think is an important one is that if you are having your healthcare expenses deducted from your paycheck, they feel a little bit invisible to you. So, you might have the sense … Young: Just like the 401(k) savings. Benz: Right. So, they are not brand new costs that we all encounter in terms of health insurance and retirement. We just may have been paying them a little more painlessly while we were employed. Young: Many of us, I know I'm fortunate this way, our healthcare costs while we are working are heavily subsidized. None of us like to see our own premiums go up when we are in open enrollment and we got to make a choice. But most workers, many workers have heavily subsidized premiums. When you think about that cost, you have to think about two things. First of all if you have subsidized premiums you might face a bigger incremental costs. You certainly want to understand that before you get there. The other thing is if you retire before you are Medicare-eligible you have different cost to consider. Now among large employers about 40% still offer some form of retiree medical, but even if you have retiree medical benefit and you have a generous subsidy, you are still facing an increase in that insurance costs most likely. Benz: Your thought is--and one of the conclusions from the research is--take it year by year rather than being overwhelmed by that single total in-retirement number. Young: Nobody says you need $600,000 for basic living, food and utilities. We take that year by year. Benz: And then another point is customize it based on what you have going on. The base case you used is that the median healthcare outlay for a 65-year-old woman would be $5,200, but those costs really ran the gamut from like $3,000 at the low end to over $26,000. If I am thinking through, if I am approaching retirement and thinking through what will my healthcare costs look like, obviously I want to take into account my own health needs and the expenditures that I am having already. Young: Your health status. It was interesting, as we went through this work with Mercer, Mercer built the model; we had a lot of input into it. When they turned over the model the first time it's this big new shining toy, what's the first thing you do? You run yourself through it. I am healthy. I just had my annual physical and my biometrics; I am healthy. And when I go through the model I come up healthy. But my parents, particularly my father, has a number of these conditions that when factored in move me from low risk to medium risk. We really spent a lot of time talking about that, because your genetic history, your parental history in particular is a predictor of what your health might be as you age. Now the good news is as we explored that. The difference between low risk and medium risk, it was $1,000 maybe on the number. It wasn't a big factor. Where the costs get really high is if you are not healthy. If you are high risk. If you have these chronic conditions, if you are overweight, if you are a smoker--that puts you in that high risk pool. It's that old 80-20 rule: 20% of the folks cost 80% of the costs. Your health, and the thing about this is, as you approach retirement, these chronic conditions, for many people they do manifest in your 50s and 60s. You actually know if you are facing a medium or a low risk health spend or if you are facing a higher health spend. Benz: The elephant in the room here is you've talked about out-of-pocket, ongoing healthcare costs. How about long-term care costs? This is just such an important topic and one unfortunately where there aren't a lot of great answers. But let's talk about how pre-retirees can approach long-term care expenses, how much they should set aside. It's really a vexing issue. Young: I think one of the contributions we're making here is we're providing people with a frame. We were talking before this interview about your personal situation around long-term care. I have personal situations around long-term care, and this is one of those topics as I am sharing our work across the country, everybody--this is personal. Everybody has a story. Some of the stories are heart-wrenching, but everyone has a story. I think what we do is we provide a frame. First of all half of folks will have zero paid long-term care expenses. That doesn't mean that they are not getting help from family and friends. But they are not paying for it. Another quarter will spend less than $100,000. We can all handle zero and most of the folks that we know and work with, $100,000 is a number that we can wrap our minds around. Now the problem is is the tail risk, the 15% of people--more likely to be women--who will spend over a $250,000. But that's 15% of people. It's really hard, we are not good at math. We're not good at putting things in perspective. These events we've all experienced around family members with long-term care are personal. They are emotional, and so we focus on those. But what we don't do well is put that in perspective to the number of folks we know that get to the end of their life never having used long-term care at all. In my own life my Grandmother Young, Lucille, she had dementia; her care was provided by my grandfather in the home. At the other extreme my Grandmother Baker, my mother's mother, she lived independently to 96. She fell, we don't know how she fell, because she lived independently. Hospital, hospice--it was very quick. That sounds like a horrible story, but Grandma Baker lived independent. Now it's a really hard thing to think about. Because as I think about this, am I Grandma Young needing two or three years of long-term care because of Alzheimer's. Or am I Grandma Baker living independent until I pass away in my late 90s. Its very hard to wrap your head around. Benz: So how do you grapple with it? Young: I think what we do, the paper came out in June, we've had the model for a while, and in our personal advisory services were starting to pilot this. So, we're testing and learning. We're testing and learning. But a big part of it is to help people understand the risk and talk through the sources of support that might be available and then help you make your personal decision around, how do you want to think about it. Your financial wealth at retirement has to cover a lot of things. One of which it could be long-term care. Benz: Jean fascinating research. Thank you so much for being here to discuss it with us. Young: Thank you. Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.